Fed: Slower pace of monetary tightening? - Westpac

Was Post Fed Chair Speech Rally a Market Overreaction

Was Post Fed Chair Speech Rally a Market Overreaction

This week, a speech by Jerome Powell, the chairman of the US Federal Reserve, triggered strong price swings in financial markets.

"A couple of participants noted that the federal funds rate might now be near its neutral level and that further increases in the federal funds rate could unduly slow the expansion of economic activity and put downward pressure on inflation and inflation expectations", said the minutes.

Powell was cited in the minutes as saying that "it might be appropriate to implement another technical adjustment in the IOER rate relative to the top of the target range for the federal funds rate fairly soon".

Almost all economists anticipate the Fed will raise rates at the upcoming meeting in December, and the Fed has penciled in three rate hikes in 2019 - though it remains to be seen whether Powell will follow through with that plan after his comments this week.

The Federal Reserve on Thursday paved the way for a fourth rate hike in December, but sent a clear signal that it would be flexible on plans to raise rates in 2019.

"The messaging from the USA over the last four weeks has been characteristically erratic", said David Page, senior economist at AXA Investment Managers.

The Fed is expected to increase rates again in December and has estimated three more increases might be necessary next year.

The central bank chief said his colleagues and many other economists "are forecasting continued solid growth, low unemployment and inflation near 2 per cent". "You slow down. You maybe go a little less quickly". Many investors read the remarks as signalling the Fed's three-year tightening cycle was drawing to a close.

The minutes from the rate-setting Federal Open Market Committee's November 7-8 meeting showed a rising level of uncertainty in the central bank about the near future. "But we know that things often turn out to be quite different from even the most careful forecasts".

"Neutral" means the rate neither stimulates nor drags on economic growth.

But, wait: Didn't the head of the Fed just give investors optimism that it was nearing its comfort zone for the cost of cash - its so-called neutral rate? At the same time, Fed officials are emphasizing they are becoming increasingly reliant on indicators and data to tell them that they are getting close to neutral. Rather, we assume that Powell wanted to prepare the markets for a change in the central bank's communication.

The minutes flagged the possibility that the Fed will make another adjustment to maintain control of the policy rate, by adjusting the separate interest rate on excess reserves, or IOER, which is now set at 5 basis points below the upper bound of the federal funds target range.

After the release of the Fed's meeting minutes, traders of interest-rate futures stuck to their bets that the Fed would slow rate hikes next year, to just one.

Tom Porcelli of RBC Capital Markets said investors were wrong to interpret Powell's words as "dovish".

The speech was "a reassuring message from a market perspective because it removes concerns of a Fed dead set on tightening up to a point where rates would intentionally slow down the economy", he added.

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