At this recent FOMC meeting, the long awaited Fed pivot finally occurred.
Although the Fed did not cut rates or anything of that matter, the language and forward guidance used to indicate that rates have peaked and the discussion moving towards the timing of rate cuts has begun.
As mentioned, rates remained unchanged this meeting, and the FOMC press statement also saw hardly any changes:
Despite this, all of the action that led to the consensus Fed pivot occurring was due to the updated dot plot that we received this week:
As seen here, FOMC participants are now expecting somewhere between 3-4 rate cuts in 2024, which is significantly more dovish than their previous SEP. As well, there was not a single member that anticipated any further rate hikes moving forward.
With markets near ATH and the economy remaining resilient, Powell could have used the SEP as an opportunity to provide hawkish forward guidance to attempt to talk down markets. The fact that he didn’t was extremely telling and shines a light on the fact that rate hikes are done and that the commentary is shifting to discussing when rate cuts will begin.
Moving towards Powell’s press conference, things got more dovish as Powell highlighted the current state of the U.S. labor market and its implications for the broader economy and inflation. The labor market, which has been surprisingly resilient through the hiking cycle, is showing signs of cooling. In November, the U.S. added 199,000 jobs, a decrease from the 240,000 average of the previous 12 months, and the unemployment rate dipped to 3.7%.
Powell emphasized the significance of this labor market shift in the Federal Reserve's strategy to tackle inflation. When labor demand outstrips supply, wages tend to increase, benefiting workers but also potentially leading businesses to raise prices to cover higher labor costs. This dynamic complicates the Fed's efforts to control inflation.
Despite the job market slowdown, wages continue to rise faster than inflation, a positive sign for household earnings, but a negative one for inflation. This cooling in the job market and the steady wage growth without a corresponding spike in unemployment are seen as favorable indicators, suggesting a move towards a more balanced labor market without triggering a broader economic downturn.
Finally, during the Q&A period, Powell mentioned a few key insights:
- In response to a question about whether the FOMC expects to cut rates to follow real rates down as discussed in our previous report, Powell said the following:
“So, you couldn't follow that like it was a rule and think that you would get the right answer all the time, but it's certainly something that we're focused on, and indeed, if you look at the projections, I think the expectation would be that the real rate is declining as we move forward.”
- In response to a question about the trajectory of QT, Powell implied that if the reason they are cutting rates is to follow down real rates and not because of broader economic weakness, they foresee a world where the FFR is going lower whilst QT is ongoing, which has never happened before:
“I think they're on independent tracks. You're asking, though, the question, I guess you're implying the question of can you continue with QT at such time, QT, which is a tightening action, at such time as policy is still tight. And the answer is it depends on the reason. You know, if you're cutting rates because you're going back to normal, that's one thing. If you're cutting them because the economy is really weak. So you can imagine, you'd have to know what the reason is to know whether it would be appropriate to do those two things at the same time.”
Based on this pivot in forward guidance and dovish rhetoric, the market was off to the races in pricing in further cuts.
In relation to this new dot plot vs 3 month term SOFR, we see that the market is now pricing in even more cuts as soon as March, with a 90%+ probability of a cut occurring then.
As well, the 2yr US Treasury bond saw a major pullback as it began to price in the shift in Fed policy. As compared to the current FFR rate, we can now see that the market regime is shifting significantly:
Overall, the time between when the Fed begins to discuss rate cuts and when it actually begins to cut is extremely bullish. Normally, the first rate cut occurs in market weakness in response to a slowing economy, but the run up to that point is a regime of speculation on easing financial conditions.
With that in mind, we believe that the stage is set for this rally to continue and even accelerate, but that the market may peak out in Q1 2024 as growth further deteriorates and it becomes evident that the Fed is cutting due to recession fears instead.
Disclaimer: This research report is exactly that — a research report. It is not intended to serve as financial advice, nor should you blindly assume that any of the information is accurate without confirming through your own research. Bitcoin, cryptocurrencies, and other digital assets are incredibly risky and nothing in this report should be considered an endorsement to buy or sell any asset. Never invest more than you are willing to lose and understand the risk that you are taking. Do your own research. All information in this report is for educational purposes only and should not be the basis for any investment decisions that you make.