"The biggest risk" in the market right now: Overheating of the US economy, stimulating the Federal Reserve!

After the release of the meeting minutes on Wednesday, the overnight economic data dealt another heavy blow to the market's expectations of an interest rate cut.

Official data shows that in December, the "mini non-farm" ADP employment figures exceeded expectations, and the US services PMI reached a five-month high, remaining in the expansion zone for seven consecutive months. The resilience of the US economy far exceeds Wall Street's imagination.

After the data was released, the increase in US bond yields expanded during trading hours, with the benchmark 10-year US bond yield breaking through 4.0% for the second consecutive day. As of Thursday's close, the S&P 500 index fell for the fourth consecutive day, and the Nasdaq hit a three-week low, with only the Dow Jones index closing higher.

The plunge in US bonds brought joy to the bears, and on Thursday, traders made large bets that US bonds would suffer heavy losses after the release of the non-farm payrolls report on Friday night. The target is for the 10-year US bond yield to soar to 4.15% by the close on Friday, a 15 basis point increase from Thursday's close. This would be the largest single-day increase in the 10-year US bond yield since the end of March last year.

Analysis believes that the biggest risk the market faces at the moment is that an overheating US economy may hinder the Federal Reserve's interest rate cut plans. The Atlanta Fed's GDPNow model predicts that US GDP growth in the fourth quarter will be 2%, which means that the Federal Reserve will "indefinitely" maintain the status quo.

An earlier article by Wall Street News, "Strong US Economic Data Worries the Federal Reserve about Difficulty in Reducing Inflation in 2024," also pointed out that behind the hawkish attitude of the Federal Reserve, there are not only hidden concerns about the two major risks in 2024 that "cannot be mentioned," but also signals of higher inflation in 2024 from the forward-looking economic data produced and monitored by the Federal Reserve itself.

Moreover, the risks do not stop there. An overheating economy can lead to a decline in bonds, and rising yields will further impact the stock market, potentially causing both stocks and bonds to fall.

How hot is too hot?

It is worth noting that before entering 2024, stocks and bonds have already been positively correlated for six months. Analysis believes that the risk lies in the fact that interest rate cuts will not come as quickly as the market imagines, and the resulting rise in yields will not only affect US bonds but also the stock market.On one hand, the US economy is still too hot, and even if inflation declines, the Federal Reserve cannot lower interest rates.

According to a report released on Wednesday, the Atlanta Fed's GDPNow model predicts that the US GDP growth rate in the fourth quarter will be 2%, still higher than the Fed's latest long-term forecast of 1.8% for the potential growth of the US economy. Considering that the US economy needs to slow down gradually, a growth rate of 2% means that the Fed will "indefinitely" maintain the status quo.

On the other hand, even if the economy slows down, as long as inflation remains high, the Federal Reserve cannot lower interest rates.

The Fed expects the inflation rate to fall to 2.4% by the end of the year, and interest rate cuts may start in the second half of this year, rather than in March as speculated by the US bond market. The Fed may not lower interest rates until the inflation rate falls below 3%.