by Alex Harding, CFA
Vice President
Equity Research and Portfolio Management
Would you have believed us if we had told you on January 1 that the S&P 500 would be up nearly 10% year-to-date after last year’s 25% jump? If this were a Vegas betting line, we would have bet against it and lost. But despite the Fed’s restrictive stance, domestic economic growth and corporate earnings have been surprisingly upbeat, propelling investors to bet that the Fed will avoid a recession and “stick the landing.” This positive sentiment has been a significant driver of the recent stock rally.
This week, as expected, the Fed left their benchmark interest rate unchanged in a range of 5.25% – 5.50% but did provide a few surprises with their forward economic projections. First, they raised the forecast for real GDP growth this year from 1.4% to 2.1%, attributing much of the rise to healthy productivity and improving labor supply. Second, they raised the year-end inflation estimate up 0.2% to 2.6% but still expect three rate cuts in 2024. By raising inflation and growth forecasts while leaving interest rate cut expectations unchanged, the Fed is increasingly confident they can “stick the landing.” Investors have priced this view into the stock market since late last year. Therefore, we believe that the Fed may only cut two-to-three times this year.
The “Great” Experiment
On Tuesday, the Bank of Japan ended its eight-year experiment of negative interest rates by raising its policy range to 0.0% – 0.1%. Outside of Japan, several other countries had utilized this highly controversial policy, including Denmark, Sweden and Switzerland, to require depositors to pay to store their money in the bank, hoping to incentivize businesses to borrow and spend at desirable rates to stimulate growth. The chart below shows that global negative-yielding debt surpassed $17 trillion in December 2020. Thankfully, the final chapter of this unorthodox monetary experiment has ended. That said, economists will continue to debate its effectiveness and future use for years to come.
Source: Bloomberg
In addition to raising interest rates for the first time in 17 years, the Japanese central bank retired the use of a practice known as “yield curve control.” This practice involved setting yield targets for a long-term government bond, such as the Japanese 10-year Government Bond, and then buying or selling as many of those bonds as needed to keep interest rates close to that level. While this approach was unconventional, it aimed to stimulate economic growth and address Japan’s chronic stagnation. However, it had severe side effects, such as significantly increasing the Bank of Japan’s balance sheet to around 130% of GDP. For comparison, the U.S. Federal Reserve’s balance sheet is approximately 27% of GDP. While challenges remain, recent wage gains for Japanese workers and healthy price inflation provide the central bank an opportunity to end an era of extraordinary monetary stimulus. In fact, Japan hit another milestone recently when the Japanese stock market finally eclipsed its 1989 all-time high, which means investors who bought the Japanese market in 1989 are now back to even.
Takeaways for the Week
The S&P 500 is up nearly 10% year-to-date after being up more than 25% last year, a surprise for investors
The Fed left their benchmark interest rate unchanged but raised both the forecast for real GDP growth this year and the year-end inflation estimate
The era of negative interest rates is over, with the Bank of Japan increasing interest rates for the first time since 2007