Investors seem to have got too far over their skis in terms of pricing in aggressive US interest rate cuts starting in March 2024.

Minutes from December’s FOMC (Federal Open Markets Committee) policy rate meeting showed participants wanted to keep rates higher for longer to see more evidence of inflation cooling down.

In addition, non-farm payrolls on 5 January came in higher than expected while wage growth was also stronger than forecast. The two positive pieces of data derailed the rate cut narrative and sent US 10-year bond yields back above 4%.

Investors reined-in their bets for a March rate cut with odds falling from 100% to around 60% according to CME Group’s Fed Watch tool.

The US economy added 216,000 jobs last month which was more than November’s 173,000 and above consensus expectations. US chief economist at Santander, Stephen Stanley, said the figures ‘absolutely argue against early and aggressive rate cuts from the Fed this year’.

However, there was a 71,000 downward revision to the prior two months’ data which means the economy added an average of 165,000 jobs in the last three months of the year.

This represents a slowdown from the 204,000 quarterly rolling average according to Dante DeAntonio of Moody’s Analytics.

While investors may have tempered their views on when the first rate cut might happen there is still a wide margin between consensus expectations which call for six or seven rate cuts in 2024 and the central bank’s view which sees three quarter-point cuts.

Key to the eventual outcome will be the strength of the economy and the trajectory of earnings. Here, the picture does not look quite as rosy with S&P 500 composite third quarter earnings per share coming in at $47.65 compared with the $50.88 expected in late September.

Fourth quarter earnings are expected to miss expectations by an even bigger margin of 8.5% according to senior index analyst Howard Silverblatt at S&P Dow Jones Indices.

The estimated year-on-year growth rate for the fourth quarter is 1.3% which is below the five-year average growth rate of 10.6% and the 10-year average earnings growth rate of 8.4% according to FactSet.

If delivered it will mark the second consecutive quarter of growth following the 4.9% recorded in the prior quarter. This means full-year earnings per share will finish 2023 around 0.8% ahead of 2022.

Looking out to 2024, consensus estimates imply 12% earnings growth, but bear in mind that typically analysts are too bullish in January and end up revising down through the course of the year. 

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