Week in the markets: all eyes on the Fed’s 2023 finale

Amid the Amazon deliveries and mince pies, investors’ main focus this week will be on the final interest rate decisions of 2023. It’s the last chance for central banks to manage our expectations about the trajectory of interest rates next year.

Fed focus

Three of the big central banks are in action this week. First up, and most important, is the Federal Reserve which is all but certain to leave rates unchanged on Wednesday at between 5.25% and 5.5%. That doesn’t mean there’s nothing to see, however. What chairman Jay Powell has to say about the path of rates in 2024 is key for the direction of markets now and into New Year.

The Fed is keen to keep us guessing. Data dependent is the mantra and that should mean that stronger growth and persistently above-target inflation could yet mean higher interest rates. Trouble is no-one in the markets believes that anymore. The consensus is that with the economy looking to slow next year, interest rates will start to fall in the spring. It’s the hope for a softish landing for the economy that’s given markets a fillip in recent weeks.

The data, to be fair, is mixed. Last week’s non-farm payroll numbers suggest that the US economy is more resilient than maybe the Fed had hoped. Treasury bond yields rose a bit after it was unveiled that 199,000 new jobs were created in November, more than expected and more than in the prior month.

Over here, both the Bank of England and the ECB are also expected to leave rates unchanged. In Europe, the case for higher rates has all but evaporated with inflation falling faster than expected to just 2.4%. Here, there’s more of a persistent inflation problem but also signs of a slowing economy as higher mortgage rates bite.

Summer correction, what correction?

The change in the interest rate narrative has provided markets with a welcome boost after the July to October correction in prices abruptly reversed about six weeks ago. Since then, markets have moved quickly back to the levels reached in the summer. And investors are now looking at the prospect of new all-time highs for the main benchmarks if the Santa Rally stays on track.

The S&P 500 index has risen by 500 points from 4,100 to 4,600 in just over a month and the late 2021 high of 4,800 is now within reach. How sustainable that will be is likely to depend on whether corporate earnings can keep delivering. After strong growth in earnings in 2021 and 2022 this year’s likely 4% decline in profits looks like being the softest of all possible soft landings.

In other markets

The prospect of a mild slowdown in activity and falling interest rates has shown up in other asset prices too. Oil, which peaked at $130 in the wake of Russia’s invasion of Ukraine 18 months ago, is back below $80 where it reflects concerns about economic growth around the world. Meanwhile, gold is benefiting from hopes for less competition from interest-bearing assets like bonds and cash next year, as well as its safe haven reputation at times of geo-political instability. At just over $2,000 an ounce, gold is close to its all-time high.

But the big winner so far this year looks likely to be bitcoin. At $44,000 the price of the most widely traded crypto currency is way above its recent low of just $16,000. The fact that it is also well shy of its $69,000 peak underscores the volatility of this riskiest of risky assets.

Optimists are focused on a cocktail of positive drivers: falling interest rates; the end of criminal trials involving the heads of two key trading exchanges; technical changes next year that will make bitcoin even harder to mine and so more scarce; and the imminent creation of spot ETFs that could bring crypto closer to the mainstream.

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