December 12, 2024: Interest rates, unemployment and the SPX

December's Federal Reserve meeting next week suggests a 25bps rate reduction. Traders are consolidating bets on a 90% chance of a cut by year-end. Still, there are concerns that price expansion will be sticky to lower. Core inflation remains unchanged at 3.30%. In addition, upside tariff threats and tax cuts magnified inflation risks. Both policies result in expansionary pressures.

The bond market and the US dollar illustrate the balancing act of persistent inflationary pressure and keeping interest rates low to support the economy (Chart 1).

Both move in tandem.

The recent run-up in September, October and November in yields reflects the trader's concerns that inflation will be more persistent than the Fed anticipates. Higher yields mean higher borrowing costs.

An elevated U.S. dollar has pros and cons. It makes imports less expensive, and multinationals that do business in the U.S. benefit. The disadvantages are from companies that conduct business abroad, exports suffer and tourism to the U.S. is more expensive.

Forecast models for the U.S. 10-year T-bond yields is for a continued support with yields averaging 4.17% - 4.20% in Q1.

Models for the Big Dollar point to 106.90 in Q1. Yields and the DXY are anticipated to be well supported over the next few months as inflation remains persistent.

Our concern for the S&P 500 in early 2025 comes not from elevated yields or a strong dollar but more from the connection that a rising unemployment rate has to the S&P (Chart 2).

Over the past 30 years, the benchmark equity index has had an opposite correlation to the U.S. Unemployment Rate. The number of unemployed individuals began to increase in mid-2023 and as steadily risen to its present 4.20%. Currently, the S&P 500 has not reacted as in past advances of unemployment.

Bottom line: Inflationary pressure remains sticky to drive down. The Fed is balancing between keeping the economy rolling forward (keeping interest rates descending) and controlling inflationary pressures (holding rate levels constant).

No easy task.