Federal Reserve Kept Rates Unchanged, Surprises with Pivot Towards Rate Cuts

The Federal Reserve kept rates unchanged in a target range of 5.25-5.50% in unanimous vote at their December FOMC, which was expected. The Fed’s move in the Summary of Economic Projections (SEP) quarterly “dot plot” however caught markets by surprise. The median federal funds rate for 2024 was lowered to 4.6%, down from 5.4% in 2023. That points to the prospect of three rate cuts next year versus only two that were projected at the time of the September SEP. It seems that the Fed has executed its much discussed “pivot” toward easier money. Stocks and bonds both rallied strongly immediately after the release.

The 2-yr note yield fell to 4.55% and the 10-yr note yield fell to 4.05%. Prior to the FOMC we saw move lower in bond yields after US data (PPI, Mortgages). Time will tell if it’s too soon for the economy. Each meeting remains ‘live’ but not very convincingly. The effects of the eased financial conditions at a curiously vulnerable point for inflation risk it would appear. Yields came off and with that the dollar lower and stocks higher.

Fed Boardroom

Federal Reserve FOMC Statement 

Federal Reserve Announcement Wednesday 1 November 2023 14:00:00 ET

The FOMC kept rates at 5.25-5.50%

Conference To Follow At 2.30 ET PM With Chairman Powell

Highlights

  • Unchanged rates
  • Target rate 5.25% – 5.5%
  • As expected, the FOMC voted to leave the target range for the fed funds rate unchanged at 5.25-5.50%. The vote was unanimous.
  • The Summary of Economic Projections (SEP) has been the initial rally point:
  • The median federal funds rate for 2024 sits at 4.6%, down from 5.4% in 2023. That points to the prospect of three rate cuts next year versus only two that were projected at the time of the September SEP.
  • The median change in real GDP for 2023 was bumped up to 2.6% from 2.1% while the median estimate for core PCE inflation was lowered to 3.2% from 3.7%. The median unemployment rate for 2023 and 2024 was maintained at 3.8% and 4.1%, respectively.
  • The median estimate for the 2024 change in real GDP was lowered to 1.4% from 1.5% (i.e. no recession, only a soft landing in that median estimate)
  • Fed Chair Powell’s press conference begins at 2:30 p.m. ET

Key excerpts from the Fed’s decision included:

  • Recent indicators suggest that economic activity expanded at a strong pace in the third quarter. Job gains have moderated since earlier in the year but remain strong, and the unemployment rate has remained low. Inflation remains elevated.
  • The opinion that the U.S. banking system is sound and resilient. Tighter financial and credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks.
  • The Committee also said it would continue to assess additional information and its implications for monetary policy. In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.

In the press conference, Mr. Powell acknowledged that the Fed has come very far with this rate-hike cycle and that the risks with policy decisions (doing too little or doing too much) have gotten more two-sided, whereas the risk in the first year or so of tightening was all on the side of not doing enough. Something else he made clear, however, is that the Fed is not considering any change to its balance sheet runoff plans nor is it talking about rate cuts at all right now. The question being asked is, “Should we hike more?”

Mr. Powell did not answer that question specifically. The fed funds futures market isn’t pricing in any more rate hikes over the next 12-month horizon; in fact, it is pricing in at least two rate cuts over the next 12 months, according to the CME FedWatch Tool.

Market Reaction

Stocks and bonds both went into rally mode immediately after the FOMC release.

The S&P 500 surged as high as 4,709, the Dow Jones Industrial Average hit a record high above 37,000, and the 10-yr note yield kissed 4.00% before bouncing. The dollar, in contrast, took a dive in response to rate-cut expectations.

The 2-yr note yield, which is most sensitive to changes in the fed funds rate, plunged 28 basis points to 4.46% and the 10-yr note yield sank 18 basis points to 4.02%.

  • The Dow Jones Industrial Average (+1.4%) surged more than 500 points to close at a new record high. The S&P 500 (+1.4%) closed above 4,700 at its highest level since January 2022. Outperformance of small cap stocks, leaving the Russell 2000 up 3.5%.
  • Notably, mega cap stocks lagged relative to the broader market. The equal-weighted S&P 500 logged a 2.1% gain and the Vanguard Mega Cap Growth ETF (MGK) rose 1.1%. All 11 S&P 500 sectors registered gains ranging from 0.7% (communication services) to 3.7% (utilities).

Market participants also adjusted rate cut expectations in response to the Fed’s latest moves. According to the CME FedWatch Tool, the probability of a 25 basis points rate cut at the March FOMC meeting jumped to 74.4% from 48.5% shortly before 2:00 p.m. ET.

Rates after release:

  • 2-yr: -28 bps to 4.46%
  • 3-yr: -26 bps to 4.18%
  • 5-yr: -24 bps to 3.99%
  • 10-yr: -18 bps to 4.02%
  • 30-yr: -13 bps to 4.18%

Prior to release:

  • 2-yr: -3 bps to 4.67%
  • 3-yr: -7 bps to 4.37%
  • 5-yr: -6 bps to 4.17%
  • 10-yr: -4 bps to 4.16%
  • 30-yr: -4 bps to 4.27%

Reviewing today’s economic data (which moved rates pre FOMC):

The Producer Price Index for final demand was unchanged month-over-month in November (Briefing.com consensus 0.1%), as was the index for final demand less foods and energy (consensus 0.2%). On a year-over-year basis, the index for final demand was up 0.9%, versus 1.2% in October, and the index for final demand less foods and energy were up 2.0%, versus 2.3% in October.
The key takeaway for the continued disinflation view is that the index for processed goods for intermediate demand was unchanged month-over-month while the index for unprocessed goods for intermediate demand declined 1.4% in November.
The MBA Mortgage Applications Index jumped 7.4% week-over-week with refinance applications up 19% and purchase applications up 4%

December 13 FOMC STATEMENT CHANGES via @Newsquawk

The full statement from the December 2023 Fed Decision

Recent indicators suggest that growth of economic activity has slowed from its strong pace in the third quarter. Job gains have moderated since earlier in the year but remain strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated.

The U.S. banking system is sound and resilient. Tighter financial and credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. The Committee will continue to assess additional information and its implications for monetary policy. In determining the extent of any additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Lisa D. Cook; Austan D. Goolsbee; Patrick Harker; Philip N. Jefferson; Neel Kashkari; Adriana D. Kugler; Lorie K. Logan; and Christopher J. Waller.

Source: Federal Reserve

From the TradersCommunity Research Desk