FOMC Update: 3 Cuts Reiterated; But The Renaissance Of The Fed Put Is The Real Gift

The benchmark index of Wall Street, the S&P 500 (SP500), surged by about 1% to a new all time high following fresh signals from the Federal Reserve and Chair Jay Powell about the rates path in 2024. While the updated FOMC projections highlight a slight shift in the rates dotplot at the extreme (expectations for more than 3 rate cuts thinned out in favor of a more consolidated consensus), which should be slightly bearish all else equal, it is surprising to note that market participants’ reaction was overall quite welcoming to the update. In that context, market participants’ bullish reaction to the latest changes in the Fed projections makes sense, I argue. In my opinion, markets should move on from focusing on the interest rates path as the major focal point in relation to the Feds contribution to markets–at this point, the arrival of lower rates is only a question of time. What investors should rather focus on, and celebrate, is the successful restoration of the Fed put as a backstop for financial asset prices in times of significant market stress.

What arguably made the recession threat during 2022-2023 so scary was the acknowledgement that the Fed won’t likely be able, or willing, to be a source of economic support. In fact, as the Powell & Co. were fully committed to restore price stability, the Fed effectively distanced itself from the potential use of any dovish monetary policy tools. But with inflation trending around 3% year-over-year, while interest rates are >5%, the Fed again looks like a well-recovered 800-pound gorilla ready to step in in times of a recession/ market stress, fighting off any “abnormal” threats to the U.S. economy. And from past observations, we know that the Fed’s tools will be very efficient and effective in doing so. This implicit Fed “put” should be much more valuable to investors than whether rates will end 2024 at 4.5% or 4.0%.

With already-bullish sentiment now supported also by the implicit expectation of a Fed put, I reiterate my thesis that the S&P 500 is poised to cruise towards a 5,400 trading price by year end 2024.

An Update On The FOMC Projections

On March 20th, participants of the FOMC unveiled their latest economic forecasts for 2024 and beyond, taking the markets by surprise with an evident shift towards dovish policy. As a key observation, I highlight that the group has broadly confirmed their inflation expectations for the end of 2024, despite inflation data in 2024 YTD coming in hotter than somewhat expected. The collective expectation among FOMC members continues to be in the range 2.3-2.4% year-over-year at consensus.

Adding to the positive inflation projection, the Fed also positively surprised on GDP growth. Notably, there was a marked increase in the projections, with expectations now set at around 2.0-2.5% year-over-year growth, up from the 1.2-1.7% forecasted in December.

Amid this environment of rising economic growth and declining inflation, the FOMC has maintained their outlook for interest rates in 2024, calling for a 75 basis points reduction.

Overall, the FOMC projections are very well in line with what I have expected heading into the meeting, arguing for the believe that the call for 3 rate cuts should persist:

Looking at the updated FOMC release, scheduled for Wednesday 20th, I expect that the Fed’s Core PCE projection for 2024 will likely increase to increase to about 2.5-2.7%, up from 2.4%, as inflation has proven a bit stickier lately that expected. However, I continue to believe that the call for 3 rate cuts will persist, as the Fed will likely point to the recent influence of season factors.

Look Beyond The FOMC Noise And Focus On The Fed Put Instead

While the FOMC projections on the U.S. economy and the monetary policy outlook remains an import input factor in investors’ asset allocation decisions, I argue that it is time for markets to look beyond interest rates as the major driver of investor sentiment. Investors should accept that FOMC’s decisions often result in immediate, short-lived market reactions that can overshadow underlying economic fundamentals. Moreover, investors should recognize that the FOMC’s communications and decisions, while important, are just one part of a broader economic landscape. By fixating solely on FOMC updates and short-term market fluctuations, there’s a risk of missing out on deeper, more structural economic driver, such as the emergent use cases of GenAI in productivity growth, as well as the technologies broader potential for new business models and value creation.

However, one of the most obvious and powerful market drivers that investors are likely missing when focusing on rates fluctuations relates to monetary policy itself — namely the central bank’s successful restoration of the Fed put. The term “Fed put” refers to the perception among investors and traders that the Fed will intervene in the market by adjusting monetary policy during periods of significant market decline or financial distress. This concept is analogous to a put option in investing, where the holder has the right but not the obligation to sell a security at a predetermined price, offering protection against falling prices. This expectation can influence investor behavior, as the belief in a “Fed put” might lead to higher risk-taking under the assumption that the Fed will help cushion any significant losses in the markets. In that context, the “Fed put” is not an official policy or strategy of the Federal Reserve. Instead, it has developed over time due to the Fed’s historical actions during financial crises or periods of market turmoil. For example, during both the financial crisis of 2007-2008 and the COVID-19 market sell-off in early 2020, the Fed took significant actions to stabilize the economy and the financial markets by slashing interest rates and buying various financial assets through open market operations. Interestingly, the lowest trading of the S&P 500 during the COVID sell-off was contracted exactly at the moment when the Fed announced its support programs for the market.

On that note, the concern surrounding the recession threat during 2022-2023 was largely fueled by the realization that the Federal Reserve might not be capable or inclined to provide economic support as it had in the past. This shift was primarily due to the Fed, led by Powell & Co., prioritizing the restoration of price stability over stimulating the economy, thereby stepping back from the likelihood of implementing any dovish monetary policies traditionally used to counteract economic downturns. However, with inflation stabilizing around 3% year-over-year while interest rates exceed 5%, the Federal Reserve is once again emerging as a silent guarantor for market prices, prepared to intervene during periods of recession or market turmoil.

Investor Takeaway

Looking beyond the March FOMC projections, investors should be less preoccupied with the precise timing of rate decreases, which seem inevitable, and be more focused on the Fed’s renewed position as a financial backstop during significant market distress. This change in sentiment is crucial, especially considering the fears of recession in 2022-2023, exacerbated by doubts about the Fed’s willingness to support the economy. However, with inflation stabilizing and interest rates above 5%, the U.S. central bank should be in an enormously comfortable position to provide investors with an implicit Fed put. Overall, as evidenced by past episodes of financial distress, the importance of the Fed’s implicit backing, or “Fed put,” cannot be overstated for investors. With the market’s mood already optimistic, bolstered by confidence in the Fed’s protective measures, I maintain that the S&P 500 is well on its way to reaching a trading price of 5,400 by the end of 2024.