We entered the Fed decision today with the 2-year yield above 5% and the S&P 500 having just delivered a down 4.7% month. And with GDP in the first quarter having just been revised down dramatically, to under 2%.
These are circumstances that were brought to us by the Fed.
By the Fed’s historically high level of real interest rates (Fed Funds rate minus the inflation rate). And by the Fed’s “sentiment manipulation” (“communications strategy”).
On the latter, the numerous public speaking engagements by Fed officials over the past three months successfully moved market expectations from one extreme (expecting as many as seven rate cuts by year-end) to the other extreme.
How extreme had expectations shifted?
As of yesterday’s close, the interest rate market was pricing in less than one full rate cut by year-end. And based on recent comments from a voting Fed member, some in the investment community had even begun to speculate that rate hikes could once again be back in play.
Moreover, if we look at the year-end expectations on where the Fed Funds rate will be, it’s projecting higher today than it was back in October. And at that time, the Fed was projecting an additional rate hike in December, and still engaged in the tightening cycle.
Now, not only does this dramatic swing in market interest rates and expectations tighten financial conditions (adding to an already historically tight real interest rate, set by the Fed), but it increases the risk of a liquidity shock.
With that, as we discussed in my Monday note, it was crucial in today’s Fed decision/press conference that they move the rate expectations pendulum back toward the middle.
So, what did the Fed Chair, Jerome Powell, have to say today?
He shot down the notion that Tuesday’s hotter wage report was an inflation concern.
He shot down the notion that the economy is settling into a stagflation stage (i.e. slow growth, high inflation). He said growth is neither slow, nor is inflation high (relative to historic stagflation periods).
And he shot down the notion that the policy path could include a rate hike as the next move. He said the discussion at the Fed is not about direction, but “how long to hold rates in restrictive territory.”
This was clearly a dovish message from the Fed today. And it countered a market that was positioned for something ranging from hawkish to very hawkish.
That should take pressure off of the interest rate market. And should provide support for stocks, coming out of an April retracement.