A Rocket That Has Lost Its Fuel

Traders on the floor of the NYSE. Photo: Brendan McDermid/Reuters

The market has, by all means, had a great start to the year. Nvidia has doubled. The Dow has repeatedly come close to breaching a historic 40,000 level. The Nasdaq has risen 11%. The S&P has risen by close to 10%.

But there’s an important catch to this market rally. The rally of the stock market in 2023 despite continuing interest rate pressure and widespread recession predictions has brought hope that despite a potentially weakening economy in 2024, the stock market will continue to rally. This shift is buoyed mainly by the easing of pressure by the Federal Reserve on the economy because of a decrease in inflation leading to interest rate cuts. Markets have penciled in three interest rate cuts that were repeatedly promised by the Fed in the first few months of the year.

And it’s fair to say that a lot of this rally in the first quarter of the year hinged on the promise of interest rate cuts. That's why the recent remarks by Minnesota Fed Chair Neel Kashkari and the jobs report on Friday present a great threat to the current bull case.

Though inflation has declined significantly from its highs in 2022, right now the inflation rate remains above its lowest points in 2023, which were themselves above target, and above market expectations. The job market continues to grow at a level that is above expectations, contributing to higher than expected inflation.

Minnesota Fed Chair Neel Kashkari. Photo: Andrew Harrer/Bloomberg

As recently as March 20th, the Federal Reserve has communicated that they still expect to cut interest rates three times this year, with the first cut likely coming in June. Now, the likelihood for an interest rate cut in June has dropped to about a coin toss, due to developments concerning inflation and the job market. Rising bond rates that plagued the stock market in October of last year began to come back as a result-currently bond rates are at a level unseen since early November 2023.

History has shown that when the Fed achieves a soft landing, it provides a powerful boost to markets, and if combined with other positive economic factors like major technological change, the stock market takes off like a rocket ship. That's what happened in the 90s, and until recently most signs pointed to a potential repeat of the market prosperity of that era, where the Nasdaq rose almost sixfold between 1995 and 2000.

Putting it simply, the factors that propelled the 90s stock market boom were strong economic growth, lowering interest rates, and major technological change. Currently, we are fulfilling two of these three crucial factors. Many assumed that the third factor, lowering interest rates, would be fulfilled this year, however the recent comments from the Fed put this all in doubt.

This could prove especially detrimental to market sectors that are especially vulnerable to interest rate pressure. Nvidia, which peaked at 970 in March, was at one point last week down more than 10% from its peak. The high-flying tech rally in the 90s was halted by high interest rate pressure, where the Fed hiked rates from 4.75% to 6.5%, causing the Nasdaq to fall more than 60% from its 2000 highs, which helped bring about a recession. This serves as a cautionary tale of how swiftly market fortunes can reverse in the face of Fed pressure. When one of a rocket’s engines stops working, there’s not enough force pushing the rocket forward, and it takes the entire rocket with it.

However, the reaction to last week's jobs report shows that there is one way that the markets can break this current conundrum, and that is for the economy to continue exceeding expectations. That was what happened on Friday when markets recovered much of their Thursday losses with the jobs report on Friday. This would prove to investors that the economy could withstand prolonged interest rate pressure.

Or alternatively, things could turn out like they did in 2000, with continuously high rate pressure that ended up causing the stock market to falter and take the economy with it. This remains a very possible scenario with the modest economic growth projections for 2024. Will the engines of the strong economy and technological change continue to push the market upwards? Currently the market is brushing up against the atmosphere, and if it fails to escape, it will remain stagnant, or worse yet, fall back to earth.