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Good Vibes

The economy and inflation are lining up as investors hoped they would.

All eyes were on the Fed this week as it held its first policy committee meeting of 2024—and even though these key decision-makers aren’t cutting rates yet, they had reasons for optimism.

Why? The latest data shows the economy is behaving like the Fed (and investors) had hoped it would after its period of interest rate hikes.

  • U.S. GDP (which measures all the goods and services produced) rose by a robust 3.3% annualized rate in the fourth quarter of 2023—down from 4.9% in the third quarter and higher than the 2% rate that had been expected.
  • Core inflation—as measured by the Fed’s preferred gauge, the personal consumption expenditures (PCE) core price index—has averaged just 1.5% annually over the past three months.

But both of those moves—avoiding or selling stocks—could potentially prove costly. The reason: Over the past 35 years, buying stocks when the market hits a new high has worked out better on average for investors than buying on any day (see chart below).

Measuring GDP and PCE Against the Fed’s Target

Source: Bloomberg, as of 12/29/23

When you factor in the Fed’s long-run target of 2% (upper range) for both real GDP growth and inflation, it’s clear that the economy is staying healthier than anticipated–while inflation is simultaneously moving lower than expected.

That’s essentially an ideal scenario in the eyes of many Fed policymakers. That said, after missing the initial surge in inflation in 2021, they’ll need to see this trend continue before deciding that an interest rate cut is in order, as Fed Chair Powell made clear this week. While that might happen at the Fed’s next meeting in March, we may not see a rate cut until later in 2024.

Of course, as we’ve noted, stubbornly high housing costs could keep inflation (and interest rates) elevated. That said, housing is a relatively small component of the PCE price index and may have a modest impact on the Fed’s decisions going forward.

The upshot: The economy and inflation are moving in the right direction—a fact we believe the Fed recognizes.

For more news, information, and analysis, visit the ETF Strategist Channel.


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