Wall St Week Ahead: Scorching US economy throws off market's Fed cut narrative

Robust US economic data is confronting investors with an unexpected question: whether strong growth can keep driving stocks higher even if the Federal Reserve delivers less monetary-policy easing than the market had hoped.

Expectations that the Fed would pivot to cutting rates sent stocks soaring at the end of 2023 and pushed the S&P 500 to a record high in January. The index is up 4 per cent this year after surging 24 per cent in 2023.

That narrative has been jolted by evidence that the economy may be running too hot for the Fed to cut rates without risking an inflationary rebound. Friday’s blockbuster US employment number was the latest sign of stronger-than-expected growth, after Fed Chairman Jerome Powell days earlier deflated hopes the central bank would begin lowering rates in March.

“Looking back on the fourth quarter and the recent rally in stocks, a lot of it was driven from the thought of a Fed pivot, and the Fed pivot is evaporating in front of our eyes,” said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management.

Market expectations of a near-term rate cut dimmed after the jobs data, with futures tied to the Fed’s main policy rate reflecting a 70 per cent chance of the central bank lowering borrowing costs at its May 1 meeting, from over 90 per cent on Thursday, according to the CME FedWatch Tool. The probability of a March cut stood at about 20 per cent, from just under 50 per cent a week ago.

With Friday’s jobs report, “the six or seven rate cuts that markets had been pricing in seems very offside,” Seema Shah, chief global strategist at Principal Asset Management, said in a written commentary.

Friday’s jobs report showed nonfarm payrolls increased by 353,000 jobs last month - well above the 180,000 increase expected by economists polled by Reuters. The economy also added 126,000 more jobs in November and December than previously reported.

Plenty of investors believe the strong growth is a positive for stocks, especially if accompanied by better-than-expected corporate earnings. The S&P 500 hit a fresh high on Friday after the jobs data, helped by the soaring shares of Facebook parent Meta Platforms and Amazon, which rose 20 per cent and 8 per cent, respectively, following their corporate results.

For 2024, S&P 500 earnings are expected to jump nearly 10 per cent after a 3.6 per cent rise in 2023, according to LSEG data. Those expectations will be tested in the coming week with another heavy batch of reports, including from Eli Lilly, Walt Disney and ConocoPhillips.

“I’ll trade a stronger economy with less rate cuts than a weaker economy with more rate cuts,” said Keith Lerner, co-chief investment officer at Truist Advisory Services.

Investors are still pricing in around 125 basis points of Fed cuts this year, LSEG data shows. That is down from around 150 basis points priced in earlier this week, but still far more than the 75 basis points the Fed has projected.