The year commenced with a surprising twist in economic indicators, challenging the Fed’s strategic balance.

Job numbers exceeded expectations, keeping unemployment at a low of 3.7%, defying the Fed’s targeted range. The recalibration of October’s unemployment figures to 3.8% further cements this trend.

Meanwhile, inflation, a pivotal factor in economic planning, displayed tenacity. After a brief pause at 3.1% in November, it rebounded to 3.4% in December, complicating the Fed’s pathway.

This evolving scenario casts shadows over investor optimism. The anticipation of the Fed cutting interest rates as early as March is now much lower.

Each month’s delay in policy shift exerts additional strain, threatening the possibility of a soft landing for the economy.

Furthermore, the robust job market, typically a symbol of economic health, now presents a paradox—indicating resilience yet complicating the Fed’s maneuvers.

Another crucial aspect to consider is the impact of low rates on struggling corporations, potentially averting a bankruptcy wave.

The Fed faces a delicate balance. Premature rate cuts could fuel a new cycle of high inflation, a scenario arguably worse than a brief recession.

The corporate sphere is already reeling from last year’s rapid rate hikes, evident in a staggering increase in major bankruptcies by 108%.

Take a look…

This trend sets a grim backdrop as we begin the year.

Bankruptcies trigger a domino effect—job losses, diminished investor confidence, tightened lending conditions—affecting not just a few, but the broader business ecosystem.

With the market’s flat start this year, the narrowing window for rate cuts adds to investor unease. If interest rates remain high, coupled with the already visible strain in the corporate sector, the stock market is going to have to pull back as a result.

In contrast, as more companies refinance their debt at higher rates, bonds are starting to look like a more reliable option.

As long as a company doesn’t go bankrupt, it has to pay back its bonds. That means investors have lower risk than they do investing in the stock market.

And today, bond interest rates are higher than they’ve been in 15 years.

On the flipside, stocks have very little reason to keep rising.

As we have covered, the market already expects the Fed to start easing rates as soon as March. If that happens, it’s not likely to make the market rally… since it’s already expected.

But if the Fed ends up keeping rates higher for longer, that could start a major market pullback.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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