During the Fed’s November press conference, Jerome Powell said there was ‘significant tightening in financial conditions in recent months.’
The Fed had projected one more rate hike for 2023, but he implied, at that moment, that the rise in bond yields (to 5% on the 10-year Treasury), weakness in stocks and strength in the dollar had already done the Fed’s job (i.e. added additional tightening). He signaled the end of the Fed’s tightening cycle.
With that, a month later, Jerome Powell was on stage giving prepared remarks at a fireside chat at Spelman College. The S&P 500 had just recorded its best November in over 40 years, 10-year Treasury yields had fallen almost three-quarters of a point and the dollar had weakened by three percent.
The conditions he cited a month prior had all reversed.
But he did nothing to push back against the idea that the tightening cycle was over. He did nothing to push back against a market that was pricing in the next move as a rate cut (and perhaps as early as March).
Fast forward (to the December meeting), and the financial conditions referenced by Jerome Powell six weeks prior had continued to ease. However, not only did Powell (and his Fed colleagues) show little-to-no concern, he all but explicitly claimed victory on inflation.
That’s a greenlight for stocks.
So, this was clear and intentional signaling from Jerome Powell, not only that the tightening cycle was over, but also that the potential for aggressive rate cuts were coming in 2024. And that did indeed give way to a huge year-end rally in stocks.
Moreover, he (and the FOMC) telegraphed the continued fall in inflation into the end of the year (through his words and through the Fed’s Summary of Economic Projections), which removed uncertainty about the next two inflation numbers.
So, on December 13th, we knew the Fed had real rates (the Fed Funds rate minus the inflation rate) at historically high levels, which continued to put downward pressure on the economy AND on inflation. And inflation had methodically, stair-stepped down to 3%, closing in on the Fed’s target of 2%. To top it off, Jerome Powell had told us they will have to start cutting rates “well before two percent.”
With all of the above in mind, by early January the market was pricing in seven quarter-point rate cuts for 2024.
But by mid-January, the Fed had successfully curbed some of that enthusiasm.
And that brings us to today’s meeting.
With all of the buildup of the past two months, and given that the market was now pricing in a, less aggressive, coin flips chance of a March rate cut, this seemed like an easy set up for the Fed to stay on the path of market expectations, by: 1) acknowledge the continued success in the path of inflation (lower), and 2) acknowledge the outlook, over the coming meetings, to reverse what has been an increasing level of restriction on the economy.
What did we get? The Fed left policy unchanged. Okay. But the Fed Chair did not follow the easy path of market expectations in his press conference.
He said they are in no rush. He said they still have the (equal) risk of acting too early (i.e. still worried that inflation stalls or starts moving higher again). He said no one proposed a rate cut today. And he said (voluntarily) that a March cut is unlikely.
This doesn’t sound like the same guy of the past two months. But that’s not too surprising. The Fed’s most effective policy tool of the past fifteen years has been perception manipulation, and Jerome Powell seemed to be wielding that tool today — tamping down the expectations that had stocks on record highs and the 10-year yield back below 4% going into today’s meeting.
The key message today: Powell thinks they have the luxury of being patient because the economy is strong, the labor market is strong and inflation is going their direction.
But, as we know, keeping this highly restrictive policy in holding pattern weakens the economy, weakens the labor market, and can accelerate the disinflation (threatening an overshoot to the downside). And that “overshoot” threatens deflation.
On that note, he did say, “very persuasive lower inflation” means they would move “faster and sooner.” Faster means bigger cuts.
Now, with all of this said, the interest rate market wasn’t too bothered by the Fed’s message of “patience.” The market is still pricing in a coin flips chance of a March cut.
And the 10-year yield finished back on the lows of the day …
As for stocks (chart below), we finish on the lows of the day, but into a big trendline that represents this “end of the tightening cycle” Fed communication timeline we discussed above …
We have a similar trendline across the Nasdaq, the Dow and the Russell 2000. So, all of these major indices trade into this big trendline support, as we head into a big productivity report coming tomorrow and the January jobs report on Friday.
If this shallow dip in stocks were to hold into this trendline and make new highs, it would be extremely bullish for stocks (confirming the technology revolution boom for stocks). We will see very soon.