A 25 bp Rate Hike, but Will It Be the Last One?
Our Views
The Fed was expected to reach a level that they consider to be sufficiently restrictive and then pause. Despite Powell’s press conference, I think we got that message pretty quickly if you look at how it got priced into the futures market. This was a dovish pause.
I think it was interesting that when asked about a pause, Powell said the minutes will reflect no support for starting the pause now but clearly implied that there was sentiment for it at the next meeting. From Powell’s press conference, I thought it was pretty clear that cuts are not on the horizon for the immediate future.
The much anticipated FOMC meeting came with dovish hopes that Chair Powell would decisively announce that the central bank was pausing, which for some would mean that the Fed was done. But it did not turn out as expected. Adding to the doves’ disappointment, Powell was adamant that he was not expecting to cut rates during the remainder of 2023 if his forecast comes to fruition, which is quite hawkish relative to the market’s view that has been pricing in between 100-200bps of easing to begin during 3Q23.
The members of the FOMC voted on Wednesday, May 3 announced it would raise rates by +25 bp, as most on the Street predicted. The vote was unanimous.
In its previous rate hike on March 22, the Fed wrote that “the committee anticipates that some additional policy forming may be appropriate.” This time, that phrase was modified–removing the words, “the committee anticipates.” Fed Chair Jerome Powell highlighted this, describing it as a “meaningful change.”
Our analysis
The stock and bond markets had immediate and contrasting reactions to the announcement. During the press conference by the Federal Reserve Chair that customarily follows such announcements, the stock market dropped sharply, specifically during three points of Jerome Powell’s remarks.
Around 2:40 p.m. (Eastern time), Powell noted that “A decision on a pause was not made today.” At 3:06 p.m., he noted that “inflation is going to come down not so quickly … it will not be appropriate to cut rates,” and at 3:18 p.m., he disclosed that “Support for the 25bp rate increase was VERY strong across the board,” admitting that Fed officials “did talk about pausing, but not so much at this meeting.” While being mindful of the “post hoc ergo propter hoc” fallacy, the timing of the accompanying market movements are nevertheless significant.
The bond markets reacted quite differently in the wake of the announcement. Bond traders anticipated the statement to mean that there was little chance of a rate hike in June. As Head of Technical Strategy Mark Newton noted, following the press statement, trading in the Fed Funds Futures was tantamount to an interpretation that the chances of a June rate hike were around 2%. Newton saw this as a more reliable indicator of what will happen: “This tends to be far more accurate as to what the Fed will do than listening to economists,” he said. “So as of now, the chance of a future hike look very slim.”
The aftermath of the FOMC decision will be seen in the coming weeks, but in the short term, Lee tied the event to market pressure on regional banks later in the day, with KRE (the S&P Regional Banking ETF) sinking in the afternoon. “What happened to the regional banks is that they fell under a lot of pressure. And maybe this is something the Fed can’t contain with the tools they have available to them.”
“You know, I'm disappointed because I think the Fed kind of raised questions about whether rates are falling,” Lee said. “We think inflation really is tracking far lower. I think next week will be where we get that clarity because that's when we get CPI numbers. Those could be quite consequential because if there's progress shown on inflation, it does sort of fly in the face of the Fed making several comments about inflation being pretty flat.”