Chair Powell’s “It’s a new phase” message dampens market euphoria
Summary
Chair Powell took a bit of euphoria out of the markets this week, even as the Federal Open Market Committee (FOMC) reduced rates by another 25 basis points. The much-anticipated Fed projections sent the markets plunging, as the Fed now anticipates only two rate cuts next year, down from four. Powell’s press conference heightened investor concerns with remarks such as, “It’s a new phase” and describing the rate cut as a “close call.” He further muddled expectations by implying that some Committee members factored in potential fiscal policy changes, contradicting his November statement that they don’t consider such factors. While the Fed headlines dominated the news last week, several other key economic releases were overshadowed, including retail sales, industrial production, housing starts, revised GDP, and consumer sentiment.
It's all about the Fed...or is it?
Although the FOMC cut rates by 25 bps, their messaging gave markets an unwanted reality check. The Fed shifted its perspective, stating that they now see more upside risks to inflation and reduced downside risks to employment. In response, long-term rates and the U.S. dollar soared. The 10-year yield rose 10 bps and continued higher last Thursday, peaking at 4.58% on the week before retreating to 4.52% after a cooler than expected PCE reading. The USD also strengthened given the Fed’s potential pause in rate cuts. Other notable central bank actions for the week showed the Bank of England (BoE) holding rates steady, as expected, as they continue to battle inflation. The Bank of Japan (BoJ) also held rates steady, which was somewhat unexpected as consensus showed a hike of 25 bps as it transitions away from its yield curve control framework.
Every Fed rate decision brings volatility, but what’s more concerning for investors is the spike in long-dated U.S. Treasurys since late September, with the 10-year yield up approximately 70 bps. While it is not uncommon for long-term rates to rise initially when the Fed begins cutting rates, this is now one of the largest increases in history, emphasizing that the long end of the curve is influenced but not controlled by the Fed’s actions. Perhaps the bond market is sending a warning that unsustainable fiscal policy does, in fact, matter, but time will tell.
Source: Board of Governors of the Federal Reserve System (US) via FRED®
Other key economic releases
Of the many economic data releases last week, a few were notable. First, retail sales were higher on the headline number at 0.7% but missed consensus when excluding vehicle sales at 0.2%. Industrial production also missed expectations at -0.1% when consensus was for 0.3% uptick. Housing starts missed expectations at 1.29M; however, permits beat expectations at 1.51M. Most of the decline in starts is from multifamily, with single family starts ticking higher on the month.
Revised GDP was higher than expected at 3.1%, and personal consumption was also revised higher at 3.7%, showing the resilience of the U.S. consumer. Jobless claims were down on the week to 220,000, which was positive news after claims were up the previous week. Finally, PCE, the Fed’s preferred measure of inflation, was released last Friday and came in cooler than expected. Core PCE remains at 2.8% year-over-year, which is clearly higher than the Fed target. Consumer sentiment came in exactly at consensus with a reading of 74.0, while showing a slight downtick in year-ahead inflation expectations at 2.8%.
In summary, the data continues to paint a mixed picture, echoing the story line of the past several months. Supporters of easing inflation argue that the Fed shouldn’t have revised its forecast so dramatically, while critics believe that the Fed should not have cut rates this week. The coming year will likely bring more bouts of volatility as the Fed continues to try to balance its mandate and plans on fiscal spending become clearer.
The week ahead
It will be a light week for economic reports due to the holiday. However, consumer confidence, durable goods, and advanced inventory data will be released.
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