The Fed hiked rate for the 6th time this year by the anticipated 0.75% and Wall Street reacted negatively at the close. But how much more pain has to come?
Let’s have a look as there are many important things to consider. There is a difference between Fed expectations and what will actually happen next. and we are witnessing that right now.
In their press release, the Fed gave the impression that they believe that all the rate hikes since March operate with a 6-month lag and therefore they might have done enough to tame inflation and they could ease the pressure or speed of further rate hikes. The first reaction of the stock market to the press release was to rally sharply. Not only did stocks take off, but bonds rallied also as the yield-to-maturity on the 10-year U.S. Treasury note fell.
But then Fed president Jay Powell made his statement during the press conference and turned the dovish press release into a hawkish one. He stated clearly and unequivocally that inflation reduction is the Fed’s top priority and saying that inflation remains well above the Fed’s goal of 2% and that the US central bank is strongly committed to bring inflation down to their 2% objective. He made it clear that more rate hikes might be appropriate, and the Fed will stay on their course until the job is done. He voiced his opinion that the Fed has some more ground left to cover and that it would be very premature to be thinking about pausing. He also cautioned that there’s no evidence right now that inflation is really coming down and vowed the Fed will not make the mistake of withdrawing their strong policy too early.
This was a reality check for the market and stock tanked. Within minutes of Powell’s speech, the dive began, and Dow fell by 2.7% by market close. The NASDAQ Composite did even worse. It fell a stunning 4.2%.
But we have something else very important to consider here. Powell did not only spoil the stock market’s party, but his comment demonstrated a change of Fed’s policy making and where the Fed will go from here. While from last March when the rate hikes began, all the focus of the market had been exclusively on how much the Fed will raise the level of rate the question is now for how long this hiking process will continue. Powell completely changed the terms of the debate with his comments.
Reading between the lines shows that the Fed has no idea what the terminal rate will be. They will keep raising rates until they meet their inflation target. In other words, this means they will only pause until rates are higher than inflation. But how long will this pause then finally last? The answer is very easy: No one knows yet, how high the terminal rate will be and no one knows how long the pause will last.
The rate hike process has 3 important parts:
1. How fast will the Fed raise rates?
2. How long will the Fed keep raising rates?
3. How long will the Fed keep rates high?
Powell offered us some idea for part 1. He clearly indicated that the December rate hike will be around 0.50%. Of course, that might change until December 14 but for now, that’s our indication for now. But there is no sign for now what will happen with part 2 and 3 within the process. By saying that the terminal rate depends on inflation, Powell left all doors open.
Finally, Powell clearly indicated that when they reach the terminal rate (whatever it may be and whenever we see it), they may have to stay there for a year a more. That could push the notorious pivot off until mid-2024.
So, it’s not about individual rate hikes anymore. Now, the focus might shift to the terminal rate and the length of the pause. And how will the markets react to this?
It’s time to be cautious. Until the Fed has clearly indicated that it’s done with rate hikes, I expect more volatility in the months ahead.
Sven Franssen