A Great Day for Bird Lovers: Powell Appeases the Doves & the Hawks

Today’s interest rate announcement from the Federal Reserve (Fed) was highly anticipated, given how the economic picture has evolved over the last month. Economic growth has remained steady, if a bit uneven, while inflation has been stickier than the markets and the Fed would like to see. Over the last month, market participants have dialed back their expectations on the magnitude of interest rate cuts the Fed will deliver in 2024 from three to one, so participants were eager to see how Jerome Powell and the Fed have interpreted the incoming economic data. The decision to hold rates steady at a target range of 5.25% to 5.5% was widely expected by market participants, and the rest of the information gleaned from the prepared statement and Powell’s press conference was generally well-balanced. A well-balanced statement was a bit of a relief for financial markets, as there has been increased chatter that interest rates may not yet have peaked and the next interest rate move from the Fed may be another hike.

On the hawkish side of the ledger (tighter monetary policy), the Fed acknowledged that “in recent months, there has been a lack of further progress towards the committee’s 2% inflation objective” and that it would probably take longer than previously expected for the Fed to gain enough confidence that inflation is under control before they can start cutting rates. On the dovish side of the ledger (looser monetary policy), in Powell’s press conference, he said that it was unlikely that the next move would be an interest rate hike and he “thinks it’s clear that policy is restrictive” (i.e., interest rates have peaked). Furthermore, Powell also said that he doesn’t see a connection between easing financial conditions and recent inflation. (I’ll come back to this.) The Fed is also tweaking the amount of quantitative tightening (balance sheet runoff) they are administering, reducing the tapering from $95bn to $60bn per month, which should give some reprieve to bond yields, as there will be less treasury supply that financial markets need to absorb as the Fed normalizes their balance sheet.

Financial markets had a muted reaction to the announcement and subsequent press conference. There was a slight surge in risk appetite that was later unwound into the close. The S&P 500 finished the day down -0.34%, while gold closed green on the day up +0.35%. The U.S. dollar had a volatile session and was down only slightly on the day, until there was a massive bid in Japanese yen after the New York close. Given the size of the yen move, it seems like this would be an intervention from the Japanese Ministry of Finance, but the rumor right now is unconfirmed. U.S. 10-year bonds finished the day up +0.65% as yields eased on the reduction of quantitative tightening, and there was a slight bull steepening of the curve as two-year yields dropped by a higher absolute amount than 10-year yields. Expectations for interest rate cuts from the Fed continue to remain at one for this year, with that cut expected to come in the November / December timeframe.

The most interesting piece of today’s Fed meeting was Powell’s comments that he views current interest rate policy as restrictive and he sees no connection between easing financial conditions and recent inflation. It continues to feel like the Fed is committed to cutting interest rates and loosening monetary policy, despite inflation remaining stickier than anticipated. My view hasn’t really changed in that if financial conditions continue to remain loose and fiscal spending doesn’t decrease, consumer demand will continue to underpin inflation, leaving us in a continuation of a “no-landing” scenario. This type of scenario doesn’t particularly bode well for longer-duration fixed income, unless monetary policy does end up being overly restrictive and ushers in an unexpected recession. I’ll continue to be watching the labour market, as material weakness here should be a leading indicator of consumer demand and the real economy.

Happy investing!

Scott Smith
Chief Investment Officer