US inflation rate declined to 3.3% in May 2024, renewing hope that this disinflation trend is sustaining and prompting the Fed to consider further interest rate cuts.
More importantly, understanding the Fed’s stance on rate cuts can be gleaned from the latest dot plot, which shows the projection of interest rates by each Fed committee member.
What the June Dot Plot says for 2024 projections:
8 officials foresee two rate cuts to 4.75-5%
7 officials anticipate a single 0.25% rate cut to 5-5.25%
4 officials see no rate cut, maintaining rates at 5.25%
The median projection is for one 0.25% rate cut. This contrasts with the March Fed meeting expectation of up to three 0.25% rate cuts.
Notably, more ‘dots’ moved higher in June’s meeting compared to March’s meeting:
This indicates a more hawkish stance, which likely explains the market pullback and weakness over the past three months. The optimistic expectations of rate cuts at the start of 2024 have mostly evaporated by now.
You might be asking, if so, why did the S&P 500 continue to break new highs this year? This is largely due to the AI narrative and the handful of stocks driving the market.
First, the semiconductor ETF (SMH) is up 56% year-to-date. This is not surprising when you look at the key holdings, with Nvidia and TSMC making up about 37% of the ETF’s weight. Additionally, other companies like Broadcom, Micron, and AMD have also delivered strong returns this year. Semiconductors are pivotal in the AI sector, providing the essential technology for companies ramping up their AI services.
Second, Big Tech is rushing into AI, with all of the Mag 7 now in the AI race. Given their significant weight in the S&P 500 and the attractive AI story driving their share prices upwards, these companies, in turn, help to propel the S&P 500 higher. If we shift the weight away from the Mag 7, an equal-weighted S&P 500 would show only a 4.66% return, three times lower than the S&P 500’s performance.
This is not a broad market recovery, but on a brighter note, it seems the recalibration of the “higher for longer” expectation has been completed. This is evident from the fact that the S&P 500 and Nasdaq Composite were up 0.85% and 1.53%, respectively, yesterday following the Fed’s meeting. The hawkish stance appears to have been priced in, or perhaps even overestimated, over the past few months.
Ultimately, I think the expectation of one rate cut has become the norm. With this uncertainty dissipating, I believe stocks can begin to climb again, and the AI narrative will continue to drive most of the index returns.
