On December 13th, Jerome Powell, Chairman of the US Federal Reserve, provided much anticipated insights into the current economic landscape, revealing that while economic activity has experienced a slowdown from its robust performance in the third quarter, inflation has shown further signs of easing. This article delves into key points from the speech and explores potential implications for major financial markets, including equities, currency pairs, and bonds.
Economic Overview
The Federal Reserve acknowledged that job gains, while moderating since earlier in the year, remain strong, and the unemployment rate remains low. Inflation, despite easing over the past year, continues to be elevated. The central bank highlighted the soundness and resilience of the US banking system but expressed concerns about tighter financial and credit conditions for households and businesses, anticipating potential impacts on economic activity, hiring, and inflation.
Monetary Policy Decision
To support its goals of achieving maximum employment and maintaining inflation at a 2 percent rate over the longer run, the Federal Reserve decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. The committee emphasized its commitment to returning inflation to the 2 percent objective. In addition to keeping current rates unchanged Powell signalled the potential for 3 rate decreases in 2024, which would mark the first drop in rates since they started rising in 2022 following the economic slowdown caused by the Covid-19 pandemic. The suggestion of rate decreases in the coming year sparked a notable rally in equities and sent the US Dollar and US bond yields falling in excess of 3%.
Future Policy Considerations
While signalling the potential of lower rates in 2024, the Committee pledged to assess additional information and its implications for monetary policy. Factors such as the cumulative tightening of monetary policy, lags in policy effects on economic activity and inflation, and economic and financial developments will influence any decisions regarding additional policy firming. The Federal Reserve also announced its commitment to continuing the reduction of holdings of Treasury securities and agency debt and agency mortgage-backed securities. Despite the Fed's repeated emphasis towards exercising caution, it seems as though a pivot towards lower rates could be expected as soon as 2024.
Implications for Markets
Equities: Following the speech, equities saw a significant rally with the S&P 500 and NASDAQ 100 both gaining upwards of +1.5%. The Fed's decision to maintain the current target range for the federal funds rate signals stability in monetary policy, which could positively impact stock markets in the longer term. Investors may find reassurance in the central bank's commitment to supporting economic goals, potentially leading to increased confidence in equities.
Foreign Exchange: Currency markets also showed a strong reaction to the Fed's update. The dollar saw a sharp dive against currencies such as the Euro (EUR/USD up over 1%) and the Yen (USD/JPY down 2%+), the latter of which has only recently fallen from near-record highs as a result of the Fed's tight monetary policy and high interest rates vs the Bank of Japan's ultra-loose policy and negative rates. If the central bank signals a cautious approach to further rate hikes, the US dollar may face longer-term pressure against other major currencies. Traders will closely monitor developments in labour markets and inflation expectations.
Bonds: In the bond market, the US 10-year yield took a dive of over 3% following the Fed's optimism around inflation and future rate decreases. The fixed-income market is sensitive to changes in interest rates, and while the Federal Reserve remains cautious about pivoting to lower rates the decision to maintain the current rate range has provided support for bond prices.
Conclusion
While the Federal Reserve's recent speech reflects a cautious approach to the evolving economic landscape, there is hope on the horizon for investors and victims of the cost of living crisis alike. The Fed's decision to keep rates unchanged and hints towards lower rates in 2024, while emphasizing the need to balance economic growth, employment, and inflation, provides investors with much-needed reassurance that inflation is under control and falling following several years of unsustainably high inflation. Whether or not 'higher for longer' rates will still be necessary to tackle long-term high inflation will still be subject to further analysis by the Fed and other central banks around the world. As markets digest this information, investors will closely monitor future communications from the central bank for insights into potential shifts in monetary policy. The overarching theme remains one of flexibility, with the Federal Reserve prepared to adjust its stance to address emerging risks and support its goals. Could this be the beginning of the end for high rates in the US?
Comments