Goldilocks and the Three Rate Cuts

Shah Gilani|January 19, 2024

There are two fairy tales in the markets right now.

One is that the Fed will cut the federal funds rate at least three times in 2024, thereby making the economy not too cold and not too hot.

The other is that 2024 is going to look a lot like 2023.

Both of these stories have traders buying up the same tech darlings they chased higher last January.

And that feels good for now. But it’s not going to last.

Traders – not investors – are running the show these days. They’re going to take profits when inflation’s downtrend stalls… when Treasury refunding announcements push rates higher… when geopolitics turn uglier… and when battlelines and bayonets are drawn between Republicans and Democrats ahead of the November election.

Meanwhile, investors withdrew almost $5 billion from equity funds last week, continuing a trend we saw for most of 2023. It’s hard to commit long-term capital with any conviction right now.

Sure, inflation is in a downtrend – falling from north of 9% in July 2021 to 4% this past December. But it is still at twice the Fed’s target rate of 2%.

Any unexpected upticks this year, in either headline or core inflation, will put a damper on expectations for rate cuts.

Fed funds futures from the end of December showed that traders were betting on six rate cuts in 2024. Today, those futures show traders betting on only three cuts. And just this week, the odds of us getting three cuts went from 70% to around 50%.

Plot Twist

Quarterly refunding announcements (QRAs) are going to add immense volatility to this year’s trading. They’re another reason long-term investors are sidelined.

Markets got an unexpected greenlight from the Treasury back on October 30, 2023, when the QRA showed the Treasury would frontload the next auction of Treasury securities by selling off more short-term bills and fewer longer-dated notes and bonds.

That so-called twist got traders very excited about buying longer-dated bonds.

If rates are coming down, they figured, it would be advantageous to lock in whatever high yields they could get in longer-duration bonds… especially if there were going to be fewer of those bonds available going forward.

It was that QRA that ignited the bond market on November 1. It lit a fire under equities and drove bonds and stocks higher through year-end.

However, upcoming QRAs aren’t going to be “twisted.” Economists say Treasury twisting costs more in interest charges on the country’s debt. The inverted yield curve is making short-dated Treasurys more expensive in terms of interest paid.

2024’s refunding requirements are exploding. Federal debt is rocketing higher, and interest on that debt is expected to cost $1 trillion this year.

That makes all those wished-for rate cuts a fairy tale.

And then there are geopolitics and domestic politics. Both are going to get hotter than a forest fire.

I’d love to get into geopolitics and all the fires we’re seeing around the world… and what could happen in the U.S. in terms of civil unrest this year as Democrats and Republicans face off… but I don’t want to scare you into hiding.

It’s going to be a volatile year.

That’s why traders are in charge today. When things heat up, they’ll take profits – because that’s what traders do.

That’s what lies ahead in 2024.

But make no mistake… I’m still bullish. That’s why I’ve been saying to buy the dips…

I’m convinced we’re going to get plenty of them.