Author: PSE Trading Trader @MacroFang

Hawkish pause from Powell on Nov 1 FOMC

The Fed has decided to leave policy rates unchanged on Wednesday at 2 PM, as anticipated.

Impact of the market was immediate. Stocks and BTC rallied — risk sentiment ON.

This decision comes despite the strong economic indicators, such as the addition of 336k new jobs in September, a 4.9% growth in Q3 real GDP, and above-target 0.30% month-on-month core PCE inflation in September.

The primary factor influencing the decision was the rapid rise in ten-year Treasury yields, reaching around 5%, which led Fed officials to pause rate hikes.

However, Chair Powell’s recent speech reaffirmed that the fundamental risk of upside inflation has not changed.

As a result, the official statement language and Powell’s comments suggest that further rate hikes are still possible. In our base case scenario, October core CPI is expected to register a 0.3% month-on-month increase, and the Fed is not projected to hike rates in December. However, if October core CPI reaches 0.4% month-on-month, a 25bp hike in December would become the most likely outcome.

The Reason for Pause: Sky High Treasury Yields

The rapid rise in Treasury yields is making Fed officials more cautious in raising policy rates, which increases the probability that the Fed will not hike further this cycle.

However, there are remaining upside risks to inflation, which means the committee cannot rule out the potential for further rate increases. Currently, policy rates are on hold, but the bias remains explicitly toward hikes rather than cuts, in line with “higher for longer” market pricing.

During the last FOMC meeting in mid-September, the Summary of Economic Projections (SEP) shows a growing confidence among Fed officials that inflation will slow to target without a recession, resulting in a true “soft landing.”

This reflects strong activity and job growth coexisting with slowing wage growth and a three-month “soft patch” in core inflation from June to August.

Considering that the prospects for a durable slowing in inflation have been overstated multiple times in the last two years, Chair Powell and the committee are careful to avoid declaring victory in fighting inflation or signaling the end of rate hikes. Instead, twelve out of nineteen Fed officials indicate that another 25bp rate hike would be necessary this year.

Hawkish Possibility: Door Open for More Rate Hikes

Keeping the door open to further rate hikes appears prescient following the data released after the September meeting. Rather than slowing, job growth accelerated to 336k in September. Although this reading was boosted by seasonal adjustment, the moving average remains above 200k per month, well above the ~100k that would match natural growth in the supply of workers. Activity also accelerated with around 2% growth in the first half followed by 4.9% growth in Q3.

Most importantly for Fed policy, core CPI and PCE inflation accelerated to above 3% annualized in September. This indicates that the slowdown in core inflation rates closer to 2% from June to August was a temporary “soft patch” driven by declines in airfares and used-auto prices, which will not continue.

Non-shelter core services inflation, also known as the “supercore,” remains “sticky,” rising faster than pre-pandemic levels, and the supercore accelerated in the most recent data for September.

One month ago, we would have expected this flow of data to lead the Fed to hike 25bp at the November FOMC meeting. This would have maintained the every-other-meeting hike pace and been consistent with the “data dependence” emphasized by Fed officials. However, the rise in ten-year Treasury yields to close to 5% has made Fed officials more cautious about proceeding with further hikes.

Fed: Cautious and Data Dependent

Despite this newfound caution, we expect Chair Powell to use the press conference to reassert that the Fed remains data-dependent and will not hesitate to react if upside risks to inflation are realized. Powell might clarify that the Fed is not trying to target a specific level of ten-year yields but is more concerned about the speed and volatility of the sell-off. This suggests that if yields stabilize, Fed hikes will remain on the table.

The key phrase in the FOMC post-meeting statement regarding rate hikes:In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.

We expect that sentence to remain unchanged. A dovish surprise would be if the phrase “extent of additional policy firming that may be appropriate” is changed to “extent to which additional policy firming may be appropriate,” as that would remove the presumption that more policy firming is likely to be needed. Policymakers are likely to keep the language as-is to avoid pricing out the potential for a December rate hike.

Fed Speak: Changes to the post-meeting statement

Recent indicators show that the economy has been expanding steadily, with solid job gains and a low unemployment rate, although job growth has slowed in recent months. Inflation remains elevated, and the Committee remains vigilant about inflation risks. The U.S. banking system is strong and resilient, but tighter credit conditions for households and businesses could weigh on economic activity, hiring, and inflation, although the extent of these effects is uncertain.

The Committee’s primary goals are maximum employment and 2 percent inflation over the longer term.

To support these goals, the Committee has decided to maintain the federal funds rate target range at 5–1/4 to 5–1/2 percent.

The Committee will continue to assess new information and its implications for monetary policy. In determining the appropriate level of policy tightening needed to achieve the 2 percent inflation goal, the Committee will consider the cumulative tightening of monetary policy, the time lags in which monetary policy affects the economy and inflation, and economic and financial developments. Additionally, the Committee will continue reducing its holdings of Treasury securities and agency debt and mortgage-backed securities, as previously announced.

The Committee is fully committed to bringing inflation back to its 2 percent target. As the Committee evaluates the appropriate stance of monetary policy, it will closely monitor incoming information about the economic outlook.

If risks emerge that could hinder the attainment of the Committee’s goals, the Committee stands ready to adjust monetary policy accordingly. The Committee’s assessments will take into account various factors, including labor market conditions, inflation pressures and expectations, and domestic and international financial developments.