The U.S. Federal Reserve Wednesday raised its key interest rate by a quarter-point, its eighth hike since March, while signaling that further rate hikes will be required despite signals inflation is easing. But the words spoken in a later press conference seemed to matter just as much, if not more, to markets - which rebounded from earlier losses.
The S&P 500 closed up 1%, reversing from an earlier loss of as much as 1% at the time of the rate decision, while the TSX closed nearly unchanged.
Bond yields in both the U.S. and Canada lost ground throughout the afternoon, with the benchmark U.S. 10-year bond down 13 basis points to 3.39% by late day.
The probabilities that money markets are assigning to further rate hikes in both the U.S. and Canada were little changed following the Fed decision and Powell’s comments. They are placing 80% odds on a 25 basis point hike to the Fed’s key rate at the next FOMC meeting on March 22.
Money markets believe that rate hikes are probably over with in Canada, however. Swaps markets suggest an 86% chance of no hike at the Bank of Canada’s next scheduled decision on March 8, and about 14% odds of a further 25 basis point increase, according to Refinitiv Eikon data. They are pricing in a strong likelihood of 50 basis points in interest rate cuts by the end of this year.
Here’s a snapshot of what economists and strategists are saying about the Fed’s latest moves:
Avery Shenfeld, chief economist, and Katherine Judge, senior economist, with CIBC Economics
The Fed delivered the highly anticipated quarter point rate hike, and at least in the text of its statement, didn’t opt to signal a pause or give any solace to markets that are pricing in rate cuts for the second half of the year. The statement retained its prior wording that referred to the need for “ongoing increases” in rates ahead, which given the use of the plural term “increases”, would seem to imply that there’s more than one hike to come. There was a slight change to the wording around future hikes, with the “extent” of future increases depending on cumulative tightening, rather than the “pace”, although that might be nothing more than reflecting the fact that having changed the “pace” to 25 bps, they were unlikely to go back to larger steps. While that was, if anything, a hawkish statement, Powell muddied the waters so much in his press conference that yields ended up lower. That’s despite the fact that the market was already pricing in rate cuts in the back half of the year, and Powell expressed his personal view that he did not see that happening.
The dovish tone came in remarks on inflation, where he had to acknowledge that the process of disinflation had begun, even though labor market slack has not yet materialized. Still, he emphasized that disinflation is coming from goods sectors (with housing set to join later in the year), and that policymakers need to see disinflation in core non-housing services to be confident about a sustainable return to on-target inflation. To get that, labor demand and supply have to come into balance, with recent readings on job openings (which jumped in the today’s data), the unemployment rate, and wage growth still indicating a labor market that’s too tight. Powell did seem much less sure of himself, perhaps reflecting diverging views on the FOMC, in terms of the near term path for rates, to some extent undermining the text of the statement that referred to “ongoing increases”. Powell emphasized uncertainty from here to the May meeting, and data dependency could result in the fed funds rate heading higher than its December projection, or if the data come in in the other direction, perhaps diverging in the other direction. That opens to door to what we expect to see, which is a further quarter point hike in March, but no further moves beyond that, as inflation continues to melt away and give the Fed elbow room to allow a less punishing path for the economy. But we share Powell’s view that an outright easing in rates in 2023 is less likely than the market expects, since we will need to see a bit of economic slack open up to assure the central bankers that having decelerated in 2023, inflation won’t reaccelerate as the economy picks up in 2024.
Derek Holt, vice-president, Scotiabank Economics
Whether deliberate or not, an initially hawkish reaction immediately following the statement then gave way to Chair Powell’s press conference that served to ease financial conditions as reflected in lower bond yields, higher equity prices and a weaker USD. .... Some of that could be due to positioning swings or markets misinterpreting the path forward.
I think a big portion of the reaction was due to the lack of conviction that Powell demonstrated during his presser as he waffled a fair bit and read pre-prepared answers to key issues. Again, that may have been either deliberate in terms of his views, or as a signal of greater uncertainty on the Committee, or perhaps it just was not his best performance and in fairness some of them have been better than others in the past. My general impression is that recent illness notwithstanding, he left his ‘A’ game behind back in December.
Powell was asked why he wouldn’t pause now. His answer was “Because inflation is still running very hot. We’re trying to make a judgement on exactly how restrictive we need to be.” That suggests uncertainty around the terminal rate.
Powell explicitly said “The Committee did not see a pause as appropriate at this meeting.”
But when pushed further on whether they discussed the conditions for a pause at this meeting, Powell deflected it by saying “Wait for the minutes. The sense of the discussion was talking quite a bit about the path forward.” That kind of comment is flagging the risk that they did indeed discuss a potential pause arriving at some point and so we will closely watch the minutes in three weeks from now. ...
My overall conclusion is to stay tuned. I think Powell spoke back and forth to multiple sides of the possibilities going forward and we’re going to be extremely data dependent on the path to the March meeting which, frankly, is ridiculous in my view. Inflation is a long game. It’s not about a handful of months. If the Fed overreacts to short-term disinflationary forces then perhaps it risks resurrecting inflation later o
Edward Moya, Senior Market Analyst with OANDA, a foreign exchange dealer
Today, Fed Chair Powell decided to not put on his hawkish tie. Risky assets recovered after Powell expressed optimism with the disinflation process and did not show concerns over the recent easing of financial conditions. Powell was Dr. Jekyll and Mr. Hyde as he tried to keep the door open for more tightening, but he kept talking about disinflation progress. Powell still thinks he can still deliver a soft landing as he believes he can get inflation back to target without killing the labor market. Powell was rather dovish as he failed to convince markets that the December dot plots could still happen. Powell added that they don’t see a rate cut this year, but it appears no one is believing that.
Taylor Schleich, Jocelyn Paquet & Warren Lovely, economists with National Bank Financial
It had been posited that Chair Powell would push back hard on market expectations in the press conference, particularly since they’ve driven the move to less tight financial conditions in recent weeks/months. However, we’d stress that unlike earlier meetings when Powell had to reign in markets expecting a pivot; (a) policy is now unequivocally restrictive and (b) inflation is actually moving lower with growing signs that the fall in inflation can be sustained. And as it turned out, there was only very gentle resistance to easier financial conditions in the presser. Rather, Powell struck a much more data dependent tone. While their inflation forecast is much stickier than ours (or the one implied in financial markets), there was an implicit acknowledgement that receipt of softer data over the coming months could alter their expected path for policy (in the near- and medium-term). It will be most critical to watch the Chair preferred inflation gauge: core services, ex-shelter inflation. Powell came back to this data point countless times, noting that they’ve yet to see much relief. We would wholeheartedly disagree given clear progress in recent months (just look at 3-month measures). So, the next time the FOMC meets in March, it’s very likely this key inflation measure (on the 6- or 12-month basis that Powell focused on) will be lower than it is today. It follows that our forecast for a lower terminal rate (than signaled in the dot plot) and cuts starting later this year is very much on the table.
David Rosenberg, founder of Rosenberg Research
There was no mention at all of any concern over the economy [in the statement accompanying the rate hike], but the release did mention that even though inflation has “eased,” inflation is still “elevated.” Unrelenting. And the statement mentioned that at least two more hikes are coming down the pike — stating the need for “ongoing increases” and that the “extent” of “future increases” will hinge on a whole array of factors. All that matters is the plural in both sentences — “increases” and not “increase.” They are signaling another 50 basis points in the next few months — into a deeply inverted yield curve, with private demand stagnating, and M2 [money supply] contracting at an unprecedented rate.
That said, we are near the end of this rates cycle. Just not at the end — even though I believe the macro backdrop is weak enough and inflationary pressures have abated enough to warrant an end to this tightening cycle right now. But remember — this is a Fed Chairman who constantly compares himself to Paul Volcker, and that means he is intent on tipping the economy into recession. Sell strength in equities, which worked all year long in 2022, and maintain a bullish posture in Treasuries. Getting paid to be in cash means a stack of T-bills isn’t a bad idea either. This tough stance should help establish a floor under the greenback.
Paul Ashworth, chief North America economist, Capital Economics
There was no forward guidance added to the statement on how long rates might remain at elevated levels, but Chair Jerome Powell suggested in his press conference that it would be for “some time”, meaning throughout this year, and that the Fed wanted to see “substantially more evidence” to be confident that inflation was on a sustained downward path. As for the peak in rates, Powell let slip that he thought it would take “a couple of more rate hikes to get to that level we think is appropriately restrictive”.
At this stage, however, we expect only one more 25bp hike at the March FOMC meeting and even that is not fully guaranteed given how quickly the data is shifting. Core price inflation is falling, wage growth is slowing, and the signs are mounting that the economy is on the precipice of a recession. We have long expected the Fed to be cutting interest rates later this year and the market now agrees.
Powell spoke at length about needing to see some decline in PCE core services (excluding housing) inflation before the Fed could be confident that inflation could be sustained at the 2% target. But the easing of labour market conditions we have already seen, illustrated by the drop back in job quits, points to just such a decline soon. Powell was also a little dismissive of the recent news that fourth-quarter ECI wage growth slowed to 4.2% annualised, noting it was still above pre-pandemic rates. But with productivity growth running at close to 2.5% annualised in that quarter (data due tomorrow), we estimate that fourth-quarter unit labour cost growth slowed to only 1.5% annualised, which suggests that the labour market is no longer a significant source of inflationary pressure.
Finally, reassured by fourth-quarter GDP growth, Fed officials still appear to be largely oblivious to the extent of the loss of momentum in real activity, which now appears to be spreading to the labour market. On January 3rd 2001, in an unscheduled move two days after learning that the ISM new orders index had plunged to 42.1, the Alan Greenspan Fed immediately cut rates by 50bp because it correctly guessed a recession was starting. Today we learned that the new orders index plunged to 42.5 last month, a low still never reached without a recession following, and yet the Powell-led Fed hiked by 25bp.
Royce Mendes, managing director & head of Macro Strategy with Desjardins
For now, our forecast continues to see the Fed raising rates 25bps at each of its next two meetings. That said, the final move we have penciled in is very uncertain and will depend heavily on the data flow, with some signs of underlying inflationary pressures already cooling slightly more than we had previously envisioned.
Michael Gregory, deputy chief economist, BMO Capital Markets
The Fed is sticking to its two-hike SEP [Summary of Economic Projections] projection for now. However, we judge the data on the ground will shift enough (i.e., an unfolding mild recession) to convince the FOMC to make it only one. However, if the data doesn’t shift meaningfully, the Fed’s going to continue tightening.
James Orlando, senior economist, TD Bank
All signs are pointing to another 25 basis-point hike in March. How many more hikes after that is hotly debated. Though we think incoming economic data will slow enough for the Fed to move to the sidelines, it has remained steadfast in its bias towards higher and higher rates.