In the lead up to the November 2 Fed meeting, investors were hopeful of a more dovish Fed after one of the Fed Chairman’s favorite advisors, Mary Daly, mentioned in an interview that it was time to talk about pausing rate hikes. This comment made on October 21 caused the stock market to rally strongly ahead of the Fed meeting as investors got complacent that the Fed would turn dovish. However, when the meeting came, they received nothing of that during Fed Chair Powell’s press conference. Instead, Powell appeared to take on an even more hawkish tone than before, which shocked many market participants who then had to unwind their positions, causing stocks to fall for the first time in four weeks.
What was it that Powell said that had the markets scrambling to take cover? We will list them down in a few simple points below.
Data Suggests Terminal Rates Need To Be Higher
To quote Powell as saying, ''the incoming data since our last meeting suggest the terminal rate of fed funds will be higher than previously expected and we will stay the course until the job is done''. This means that according to what the Fed is seeing from the data that they calibrate, the fed funds rate at the end of this tightening cycle will have to be higher than what they previously expected, which was a rate of 4.63%. Effectively this would cause the Fed to set a fed fund rate of more than 4.63%, possibly 5% or more, due to the data they receive about the economy, before they would even consider a pause.
Rates Need To Keep Up With Inflation
To give more context as to why he was suggesting that data says that fed fund rates need to go higher, Powell said that it was more important to determine for how long rates will remain high, rather than think about a pause. Specifically, he elaborated that since inflation is currently more than 5%, the Fed will need to keep raising rates until the fed fund rate is at least on par with the inflation rate and the Fed will “keep at it until the job is done”. This was a scary comment as that would mean fed fund rates of 8% should inflation remain where it is today, which means rates could still double from where they are today, which totally scared the living daylights out of investors.
Risks to Not Tightening Enough
If his previous comment was not hawkish enough, Powell went further to elaborate that the risk of not tightening enough outweighs the risk of over-tighening. The Fed Chair said that they could still use various tools to support the economy should they be needed later on if they were to over-tighen, but if they failed to tighten enough, inflation would become entrenched and that would be a much bigger problem. Powell specifically mentioned that this move to have an over-tighening bias is part of their risk management strategy, justifying the need to continue hiking rates.
Premature to Pause But Hikes Could Decrease
While investors were hoping for a pause or even a pivot to dovishness, what Powell said made it very clear to the wishful thinkers once and for all - that if there was a pivot at all, that it was from hawkish to even more hawkish, as Powell clarified that it was premature to even be thinking about pausing.
That said however, Powell did mention that they could slow down the rate of increase in the December or January meeting from 75-bps to a lesser amount, depending on what the incoming data in the coming month says. This means that the upcoming core CPI number to be released on November 10, and the core PCE number to be released at the end of November, could be even more crucial as the Fed will decide how much to hike depending on how inflation is doing. Should inflation continue to stay heightened, the Fed could stick with a 75-bps in December.
A stronger than expected labour market has thus far not given the Fed any reason to reduce their rate hikes either. Thus far, the jobs market appears to be still strong, with the nonfarm payrolls coming in at 261,000 versus expectation of 195,000 jobs created in October. Although the unemployment rate has risen from 3.5% to 3.7%, the JOLTS jobs opening report released on November 1 shows that job openings have increased from 10.28 million in September to 10.72 million in October, when consensus expectation was for the number of job openings to fall to 9.75 million. In other words, the job market still looks strong despite the unemployment rate having risen a little. The labour market is another factor that the Fed will look into when deciding on whether the economy can support higher rates and thus far, they are showing that the labour market has not been as affected by the higher rates as anticipated yet, which will leave the Fed with no excuse to not continue to hike. This is also why the upcoming inflation numbers will be very keenly watched - that is the bulls’ only hope.
With the above, we have summarised the essential takeaways that the latest Fed meeting has given us and hope that our readers can use them well to make informed investment decisions.