The market could be rallying itself out of the Fed interest rate cuts it wants so badly

Published Tue, Dec 5 20236:47 AM EST

Rallies in the stock and bond markets could be undone by the very thing that seems to be underpinning the moves higher. A risk-on push that began in early November has coincided with hopes that the Federal Reserve is not only done raising interest rates but also within the next several months actually will start cutting. However, as stock averages surge higher and Treasury yields fall, the easing in financial conditions is just the kind of thing that would cause Fed officials to worry that inflation could rear its ugly head again just when it looked like it was coming under control. Fed Chair Jerome Powell "has lost control of the narrative just a little bit with the expectation of a quick cut," Roger Ferguson, a former vice chair at the central bank, said on CNBC's " Squawk Box " during an interview Monday. "They want to avoid the old stop-and-start concern, which means they may hang on just a little longer than markets expect." Powell delivered a speech Friday that seemed to have a hawkish tone in favor of tighter policy. He explicitly cautioned that talk of cutting rates was "premature" and that more hikes are still on the table if inflation doesn't continue to show progress back to the Fed's 2% annual target. However, the market chose to hear only parts of the speech in which Powell seemed to indicate that further rate hikes are probably not happening, and rallied accordingly. The Dow Jones Industrial Average hit its high of the year, and Treasury yields continued a march lower that has seen the 10-year note shave off about three quarters of a percentage point over the past month and a half. Bond yields move inversely to their prices. "I don't believe Jay Powell when he woke up Friday morning was expecting or wanting the reaction in the markets we saw to his speech that he gave that day," Peter Boockvar, chief investment officer at Bleakley Financial Group, said in a morning market note Monday. "Who pushes who around? The markets or the Fed? Sometimes it's the latter, but now it seems to be the former," he added. The Fed relies on an amorphous group of indicators collectively known as "financial conditions" to help judge the state of play on policy. Stock and bond prices are two of a multitude of factors that go into the equation. When the markets are on a roll, that usually coincides with a loosening in those conditions. True to form, a Chicago Fed baromete r is showing financial conditions at their easiest since early February 2023. That won't be lost on members of the rate-setting Federal Open Market Committee when they meet next week. "Financial conditions, which had been tightening, supporting their narrative, are now starting to ease and so I think they're caught in a little bit of a dilemma," Ferguson said. "They see inflation dropping, [and] that should give them some room to ease. But I think they don't want to be premature, because they also know there's a risk of the economy restarting with the loosening of financial conditions. So it's a complicated story." Markets think it's simpler than that: Traders in the fed funds futures market are betting that the Fed starts cutting in March 2024 and ultimately lops off a total 1.25 percentage points before the end of the year, according to CME Group data . Wharton professor Jeremy Siegel told CNBC on Monday that Powell, following the meeting, should say that rate cuts are at least "part of the conversation." But Ferguson said the only likelihood of aggressive cuts is if something should go substantially wrong in the economy, which at the least would pose a threat to the current rally. "If they are cutting rates in the first half [of the] year, it is because they are more concerned about a slowing than they are about a restart," he said. "That does not necessarily support the 'happy days are here again' everything-rally that we're currently seeing in the market."