In the past three weeks, Bloomberg’s Fed speak index has shown a marked decline, indicating a more dovish tone from Federal Reserve members. This shift comes as the Federal Open Market Committee (FOMC) prepares to meet with new voting members from Chicago, Boston, St. Louis, and Kansas City. While the market is not expecting a rate cut at this meeting, financial markets are keenly observing the Fed’s stance amid global economic dynamics, including China’s advancing artificial intelligence capabilities, which pose a significant threat to US tech stocks.
The Reserve Bank of Australia is anticipated to cut interest rates in February as financial markets predict eased price pressures. This global trend of potential rate cuts starkly contrasts with the Fed's relatively stable interest rate expectations. Despite this stability, there are speculations that the Fed might soften its hawkish tone, potentially impacting FX markets and encouraging rallies in cyclical stocks and US midcaps like the Russell 2000.
The upcoming FOMC meeting will not include a summary of economic projections or Dot Plot but will be followed by a press conference. The Fed has expressed its desire to keep inflation expectations well-anchored, suggesting a cautious approach at the meeting. Since April 2024, 1-year US inflation expectations have remained above 3%, slightly rising following a 50 basis point rate cut in September. The University of Michigan's inflation expectations measure has also edged higher at the 1-year horizon, staying above the Fed’s target rate for the long term.
Despite the lack of expected immediate rate cuts, market predictions suggest less than two rate cuts from the Fed this year. The interest rate expectations for 2025 have remained largely unchanged since the beginning of the year. These stable expectations come even as other central banks have faced increased bets on interest rate reductions in recent months.
The dovish signals from the Fed could potentially boost UK equities, given the strong positive correlation of 77% between UK 10-year yields and US 10-year Treasury yields. Any indication that the Fed might accelerate its pace of interest rate cuts could trigger a rally in cyclical stocks, benefiting sectors sensitive to economic cycles.
China’s burgeoning AI capabilities present a looming threat to US tech stocks, overshadowing concerns about the Fed's monetary policy. This development could influence investor sentiment and drive strategic adjustments in tech portfolios.