Stocks extended gains, and bond yields fell further, after Fed Chair Jerome Powell’s press conference this afternoon that accompanied the U.S. central bank’s decision to hold its key interest rate unchanged.
Markets and economists took commentary from the Federal Reserve as leaning to the dovish side. That helped to propel stocks higher - the S&P 500 and S&P/TSX Composite Index both closed just over 1%, at session highs.
And it also helped to tame bond yields. The U.S. two-year bond yield by late afternoon was down 11 basis points to 4.95%, its lowest point of the day. The two-year Canada yield was down about 6 basis points, also at North American session lows.
Bond markets priced in modestly lower odds that the Fed will hike interest rates at its next meeting in December in the wake of the Fed press conference.
Decisions by the U.S. Federal Reserve have considerable influence on Canadian markets and monetary policy. For both Canada and the U.S., money markets are pricing in a strong likelihood that central banks will be cutting interest rates in the second half of next year. Those bets have been on the rise in recent days, especially for Canada.
The following table details how money markets are pricing in further moves in the Bank of Canada overnight rate, according to Refinitiv Eikon data as of 330 pm ET Wednesday, around the time the Fed’s press conference concluded. The current Bank of Canada overnight rate is 5%. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves.
And here’s how interest rate probabilities are faring for the key federal funds rate in the U.S. Currently, it rests in a target range between 5.25%-5.5%, where it has been since July.
This what market strategists and economists are saying about today’s Federal Reserve decision and commentary:
Michael James, managing director of equity trading at Wedbush Securities in Los Angeles
He wasn’t as assertive about higher-for-longer, as he has been in the past. That’s one takeaway bulls will be focused on, even though he indicated the Fed still has a ways to go to get to its 2% target.
Andrew Hunter, deputy chief U.S. economist, Capital Economics
By leaving rates unchanged while continuing to flag the possibility of further tightening to come, the Fed indicated today that it remains in ‘wait and see’ mode. But we suspect the data over the coming weeks will see the case for a final hike continue to erode, with the Fed likely to start cutting rates again in the first half of next year.
The decision to hold the fed funds target range at 5.25%-5.50% was unanimous, while the statement was little changed. Admittedly, following the 4.9% annualised surge in GDP in the third quarter, the description of activity growth was upgraded from “solid” to “strong”, with the recent pace of jobs growth given a similar description. The statement about “the extent of additional policy firming that may be appropriate” was also retained. But in a more dovish addition, the statement now notes that “tighter financial and credit conditions… are likely to weigh on economic activity, hiring, and inflation” (previously it referenced credit conditions only). That is clearly a nod to the surge in long-term Treasury yields in recent weeks, which a number of officials have suggested could reduce the need for further rate hikes.
While there is still a chance that the Fed will squeeze in a final 25bp hike at the December or January meetings if economic growth continues to surprise on the upside, the recent surge in long-term bond yields suggests that is increasingly unlikely. Even if growth remains stronger than we forecast, the conditions are already in place for inflation to continue falling regardless – and at a faster pace than officials expect. Overall, we still expect the Fed’s next move to be a rate cut, with rates falling to a below-consensus 3.25%-3.50% by the end of next year.
David Rosenberg, founder of Rosenberg Research
The Fed looks done. All it needed to do was sneak in the word “financial” into one sentence to seal the deal. As in: “Tighter financial and credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation.” This confirms our view. It is strong forward guidance. The tightening in financial conditions since the September 20th meeting has been equivalent to at least two hikes (between what the blended equity and debt cost of capital has done along with the surge in mortgage rates and firming in the U.S. dollar). Enough is enough. While the statement acknowledged yet again that inflation remains “elevated,” the Fed believes it will continue to trend lower. Meanwhile, the Atlanta Fed Nowcast model just dragged the Q4 real GDP growth estimate down to a stall-speed of 1.24% at an annual rate from +2.26%.
Edward Moya, senior market analyst, The Americas, OANDA (foreign exchange firm)
Fed Chair Powell tried to preserve optionality, but he didn’t seem very convincing. He noted that the Fed has gone from penciling in one more rate hike to now asking the question ‘Should we hike more?’ Powell still anticipates they need to see a softer labor market and growth, but refrained from saying they would bring some pain to households and businesses. It is clear the Fed does not know when we will feel the full impact of their tightening cycle and that they will go meeting by meeting in deciding if inflation is warranting further rate hikes.
Fed Chair Powell tried to talk a hawkish game, but he wasn’t convincing enough. The Fed’s September dot plots and forecasts are already in the trash and it seems likely that the next move will be a rate cut.
Ali Jaffery, executive director and senior economist, CIBC Economics
While the statement was broadly unchanged and maintained the data-dependent character, Powell struck a more dovish tone in the Q&A in our view. He certainly kept the door open to further rate hikes saying clearly that he was “not confident” that the current level of monetary policy was restrictive enough and that the tightening in financial conditions would need to prove persistent in order to substitute or alter the path of future monetary policy. However, the main takeaway for us was the sanguine explanation for the recent strength in the economy, mostly implying it had a limited implications for future inflation. He repeatedly emphasized the improvement in the supply-side of the economy and the unwinding of the pandemic effects as being a potential explanation of the recent strength in the labour market and GDP. On GDP, he went as far as to suggest that the recent improvement in labour supply, partly driven by immigration, could imply a higher level of potential GDP. On inflation, he did not discuss the flattening out of underlying inflation measures produced by regional Feds or the upturn in “super core” measures watched by the Fed. Here he noted substantial progress in recent months although not sufficient and that wage inflation also has moderated in line with the Fed’s expectations. He did note that the supply-side improvements on inflation would likely subside and the emergence of excess demand conditions could build inflationary pressures, but it was far from his emphasis. Another very important signal from the Fed was the change in the risk bias from “not doing enough” to “doing too much” and the risks becoming more balanced. This change in bias is likely the start of a slightly different data-dependence regime in which the Fed takes longer pauses to assess data and determine the course of policy as Powell seemed to imply. This came out in a question when asked about monetary policy lags and Powell expressed his uncertainty around making precise assumptions about monetary policy lags and wanting to “slow down” to assess the data. In part, the dovish tone was needed to justify the action of today’s pause and certainly the bar for the Fed to move again seems to have nudged up a bit. But we remain a bit skeptical. Powell laid out very clearly what he is looking at for December: two more labour reports, two more CPI prints, some activity data and now, the durability of financial conditions tightening. We’ll be watching those too, and keeping a keen eye on the evidence that the supply-side improvement in the economy has enough legs to explain the upsurge in consumption.
Tiffany Wilding, economist, PIMCO
Federal Reserve Chair Jerome Powell declined to nudge he market pricing toward the hike that many Federal Open Market Committee (FOMC) members projected at their September FOMC meeting. Instead, Chair Powell suggested that a continuation of above trend growth was needed to garner additional rate hikes, and that the current trend growth may be elevated as a result of the post-pandemic normalization in immigration, and the more general improvement in labor force participation.
By not more forcefully nudging the market, Powell reinforced the current market pricing of around only a 20% chance of a rate hike in December. The onus is on the data between now and then to knock them off of that track.
While growth was incredibly strong in the third quarter of 2024 (3Q24) at 5%, we suspect a substantial slowing in 4Q24, which, based on Powell’s remarks today likely won’t be enough to garner additional tightening. Instead the FOMC is happy to remain on hold, and watch and see how the economy evolves early next year, in light of the recent tightening in financial conditions and higher term premiums. Taking a step back, the central bank is balancing this resilient economic data in recent months against tighter financial conditions. Based on the November FOMC meeting, tighter financial conditions seem to be winning out for Fed officials for now.
Derek Holt, vice-president and head of Capital Markets Economics, Scotiabank
It is my opinion that the Fed inappropriately eased financial conditions and egged on financial markets to more aggressively price rate cuts next year. Inflation risk remains pointed higher in my view in an economy that is performing very well. If easing financial conditions continue, then the Fed might have set itself up to behave more erratically next month.