The Take From the FED and Market Implications

Yesterday we had the FOMC meeting and the market reaction, characterized by a dovish sentiment was evident. The market is now pricing in 81 basis points (bps) in policy easing for the year, compared to 75 bps earlier. This adjustment reflects increased expectations for monetary policy accommodation in response to economic conditions, which sent the US Dollar more than 100 pips lower yesterday.

US 2-year yields declined by 7.5 bps on the day, while the US dollar returned to the lows, further highlighting the market’s dovish response. Powell’s remarks during the press conference did not signal a shift towards a more hawkish stance. Instead, the possibility of a rate cut in June remains on the table, contributing to the dovish sentiment regarding the USD, but bullish for risk assets such as stock markets and commodity dollars in particular.

The probability of a June rate cut has increased significantly following the FOMC meeting and Powell’s press conference. Before these events, the probability was around 50%, with slight fluctuations depending on when one last checked the tool. However, following the meeting and Powell’s remarks, the probability of a rate cut in June has surged to just below 70%.

This substantial increase likely reflects market participants’ interpretation of the Federal Reserve’s dovish stance and their expectations for future monetary policy adjustments in response to economic conditions. Below is an organized summary of Jerome Powell’s comments by topic:

Employment and Labour Conditions:

• Powell emphasized that strong job growth is not a cause for concern regarding inflation.
• He reiterated that strong hiring alone would not deter the Federal Reserve from considering rate cuts.
• Powell noted that a robust labor market, characterized by balanced supply and demand, could support a larger economy without significant inflationary pressures.
• Overall, Powell viewed the labor market as being in good shape, with conditions returning more to pre-pandemic levels.
• He observed that wage growth was moderating to more sustainable levels and that extreme imbalances in the labor market were mostly resolved.
• Powell mentioned that the Fed closely monitors layoffs and emphasized that initial jobless claims remain very low.

Inflation Expectations and Financial Policy:

• Powell underscored the importance of bringing inflation down to a sustainable level and indicated that recent inflation data hasn’t altered the Fed’s objective of reaching a 2% target.
• He stated that decisions about future meetings would depend on incoming data and reiterated the Fed’s commitment to gradually bringing inflation down.
• Powell expressed the need for greater confidence in inflation moving sustainably lower before considering rate cuts, although it’s likely rates could be cut at some point in the year.
• He suggested that the policy rate may be at its peak and emphasized the Fed’s cautious approach in responding to economic data.

Overall Economy Economic Outlook:

• Powell highlighted measures to limit risks to money market volatility and discussed plans to slow the pace of balance sheet runoff.
• He mentioned the Fed’s intention to return to a balance sheet that primarily holds Treasuries and acknowledged the importance of learning from past mistakes regarding balance sheet management.

Interest Rate Cuts and Monetary Policy:

• Powell acknowledged the likelihood of rate cuts this year but emphasized the uncertainty surrounding these decisions.
• He expressed his instinct that rates would not return to very low levels seen in the past, indicating a cautious stance towards future rate movements.