Fed 'Goldilocks' strategy still in play, says Goldman Sachs

Traders were prepared for Jerome Powell to push back against their optimism over interest-rate cuts — and when he didn’t, buy signals flashed across Wall Street.

Global stocks and bonds extended gains on Thursday after Fed policymakers kept rates on hold and continued to pencil in three quarter-point cuts this year. A surprise decision by the Swiss National Bank to lower its benchmark rate further boosted market confidence that monetary policy has indeed peaked in most developed nations, with the Bank of England set to announce its next steps later today. US equity futures climbed, while yields on two-year Treasuries — those most sensitive to monetary policy — fell 3 basis points to 4.57%.

While Powell emphasized the US central bank was mindful of the risks of easing too soon, he downplayed recent inflation readings that rattled markets, saying it didn’t alter the longer-term outlook. The Fed chair underscored he’s ready to act if the economy’s surprisingly strong run stalls.

“The ‘Goldilocks’ narrative is still very much in play,” said Eric Sterner, chief investment officer at Apollon Wealth Management. “While the Fed stuck with their projections for three interest-rate cuts later this year, policymakers also raised their economic growth expectations and lowered unemployment forecasts. That is giving more fuel to the soft-landing narrative that the stock market loves.”

Wall Street traders have a long history of hearing what they want when it comes to the Fed. That led them to underestimate how far the central bank would go after the rate-hike cycle began in 2022, then to prematurely bet on a rapid about-face once the economy snapped under the impact. 

But the market’s latest reaction is a signal of how closely investors are now aligned with the Fed. 

By late last year, traders were still betting the central bank would ease far more than policymakers were projecting. But after data showed inflation was stickier than expected in January and February, they rolled back those wagers and effectively capitulated to the central bank’s view. The major concern was that the Fed on Wednesday would reduce its forecast for rate cuts this year.

When that didn’t happen, there was a wave of relief and investors bid up the prices of assets of all stripes. Major exchange-traded funds pegged to stocks, shorter-maturity Treasuries, investment-grade bonds and high-yield debt all rose at least 0.2%, marking the fourth-strongest advance of that scope for any Fed decision day since June 2019. Even beleaguered trading positions — such as bets the yield curve would steepen on the longer-term growth outlook — received a boost.

The assurance carried through to Thursday. The benchmark MSCI Asia Pacific Index enjoyed its best day in more than four months, while a Bloomberg gauge of commodity prices rose to its highest level this year. 

“This is a Fed that really wants that soft landing to continue,” said Priya Misra, a fund manager at JPMorgan Asset Management, speaking on Bloomberg Television. “It was never going to be a straight line down to 2%,” she said, referring to the central bank’s inflation target.

STOCK GAINS

The Bloomberg Dollar Spot Index posted its biggest losses in almost two weeks in the wake of the decision before trading little changed on Thursday. Rate cuts are ultimately likely to weigh on the currency. The Swiss franc plunged against both the greenback and the euro following the SNB’s decision.

The Dow Jones Industrial Average and Nasdaq 100 index both rose more than 1% Wednesday. That was in part due to the prospect that earnings would keep growing on the back of the robust economy, with the Fed boosting its growth forecast for this year to 2.1% from 1.4%. 

Bonds are still down for the year, with previous selloffs leaving Treasuries with a loss of some 1.6% for 2024, according to a Bloomberg index. They slid 12.5% in 2022 and were down for much of 2023 until a late year rally pushed them to a 4.1% gain. 

During his press conference, Powell wouldn’t give any clear indication of when rate cuts may begin. He just said the first would likely be “at some point this year” and hinge on the incoming data. He also said the Fed saw the risks balanced between inflation and slowing growth.

“It felt to me there was a desire to not abandon the dovish pivot — and Powell certainly sounded that way in the press conference,” said David Rogal, a portfolio manager at BlackRock Inc.

Not all of the Fed’s data were supportive of markets. The projections boosted the median forecast for where the central bank’s key rate will end 2025 to 3.9% from around 3.6%, taking one cut off the table, and the estimate of the longer-run rate edged up to about 2.56%. Policymakers also raised their 2024 forecast for underlying inflation to 2.6% from 2.4%. 

A robust jobs report in Australia underscored the risk that higher-for-longer rates will be needed to tame inflation in other developed markets. Aussie three-year yields rose five basis points 3.71%. 

“The markets reaction makes sense,” said Mike Sanders, head of fixed income at Madison Investments. “The dots still said it will be 75 basis points and Powell said it would be appropriate to cut this year if everything goes how they think. We care less now about when they start as it’s about where they finish.”

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