Chairman Jerome Powell spoke today at the Economic Club of New York and his comments generally surprised markets in that they seemed to suggest current interest rates may be close to neutral. This is a stark contrast from Powell’s October 3rd statement where he said “…we may go past neutral. But we’re a long way from neutral at this point, probably.” At the time, this was interpreted to mean that markets should expect a steady path or rate hikes over the next few years. And it was this comment that proved to be the catalyst that sparked a selloff in equities as you can see below.
Today Powell took a decidedly different tone. Here’s the part in today’s speech that is getting all the attention (emphasis is our own):
“Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy–that is, neither speeding up nor slowing down growth.”
Essentially this means that if current rates are close to what policy makers believe is a neutral level, the Fed may not hike as much as was previously expected. Said differently, Chairman Powell, like his predecessors, will be data dependent and likely sensitive to signs of a slowing economy, lack of meaningful inflation, a labor market at full employment etc.
It Was a “Risk On” Type of Day
Global equities rallied on this dovish shift and after a fair amount of volatility post-speech, bond yields closed out the day relatively unchanged with the 2-year bond down -2bps and the 10-year closing flat.
Here’s how the major asset classes reacted to today’s comments:
The asset classes that have been hit the most since the beginning of October were the ones that rallied the most today – i.e. technology, small cap and emerging market stocks. If the prior two months have been “risk off,” today was certainly a complete reversal of that dynamic where the more volatile asset classes outperformed – it was indeed “risk on.”
What Does This Mean for 2019?
Powell’s comments didn’t change the market’s opinion about a potential rate hike in December – the odds of a 25bps increase still stand around 80%. And while the odds of a hike in March did decrease a bit, it wasn’t drastic. The debate centers around what the rest of 2019 will bring.
Prior to today there were really two schools of thought regarding policy in 2019. One camp thought the Fed would raise rates more aggressively in an attempt to tame inflationary pressures from an overheating economy. Most on this side thought the Fed would hike 4 or so times next year. The other camp thought there was a good chance of the Fed being more cautious – say one or two hikes. After today’s news, the market is pricing in only one hike for 2019 – a clear win for camp two…
We’ll get new “dots” via the Fed’s updated economic projections after the December 19th meeting (the ones above are from September). Given today’s comments and the wide discrepancy between where the Fed and the market see the future Funds Rate, it seems likely the FOMC will lower their “dots” to a level closer to the market’s expectations.
There are a series of events over the next few weeks (including the release of the FOMC meeting minutes tomorrow) where members of the committee will be making public comments. Will this Fed speak add further clarification to Powell’s comments? We’ll have to wait and see.
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