Monex Europe: Cautious optimism killed the Fed’s message

Monex Europe: Cautious optimism killed the Fed’s message

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Simon Harvey, Head of FX Analysis at Monex Europe, comments on today's Fed meeting.

The Federal Reserve today hiked the target range for the Fed funds rate by 25bps to 4.5-4.75%, meeting both our expectations and those priced into money markets. Within the rate statement, the Fed tweaked language relating to their view on economic conditions ever so slightly. While it retained language that the economy continues to grow at a modest rate and that the labour market remains robust, it now references the fact that inflation has started to ease “somewhat”.

This follows recent intermeeting communications by Fed officials after January’s PCE data showed continued disinflation in headline and core PCE. The main tweak in the rate statement from December’s edition was the inclusion that the “Committee anticipates that ongoing increases in the target range will be appropriate”.

This will come as no surprise to Fed watchers as the FOMC continues to cast a hawkish tone to prevent a further loosening in financial conditions while it decelerates the pace of its hiking cycle and rates approach the terminal level. Although the language used within the rate statement was suggestive of what was set to occur within the press conference, this wasn’t necessarily the case.

While the press conference began with a reiteration of the rate statement released earlier, with Powell reinforcing the message that the Fed was “not yet at a sufficiently restrictive stance” and that there remained “more work to do”, the overall tone of Powell’s public commentary soon started to turn from resolutely hawkish to cautiously optimistic.

This was quickly picked up by market participants and resulted in a renewed unwind in US financial conditions. The dollar sold off, equities rallied, and more rate cuts were priced in for the second half of 2023, which weighed on the US Treasury curve as a whole.

Chair Powell’s press conference stimulated renewed pricing of Fed cuts in H2 2023 as per the eurodollar futures curve.

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Although littered with references to the lack of progress in non-housing core inflation, which accounts for over half of the core CPI basket and has yet to show signs of disinflation, it was the comments Powell did make on the progress made so far and what he didn’t say when questioned on the December dot plot, that ultimately engaged market participants. These signs of cautious optimism from Chair Powell fed into their priors and confirmed their expectations that rate cuts are firmly on the table for the second half of the year. 

Just two questions into the 40 minute long Q&A, Powell started to confirm the markets underlying bias as he mentioned that the recent signs of disinflation in the inflation data was “gratifying”, while a question on the balance of risks to the terminal rate shortly after saw Powell state that the Fed had “no incentive [...] to overtighten”, while refraining to comment on the viability of December’s dot plot given recent data.

Not satisfied with that answer, journalists continued to press Powell on how markets aren’t necessarily buying the Fed’s previous forecasts and moved the spotlight to the second half of the year. A question specifically on the inversion of the swaps curve was then thrown his way, and while for other central banks like the ECB this would have been the perfect time to massage market expectations, Powell highlighted that if inflation comes down as quickly as markets imply, the possibility of rate cuts will certainly come into the FOMC’s deliberations.

Whilst a statement of the obvious, this was perhaps not the time or place to mention it, with markets inferring a further dovish signal and EURUSD tagging the 1.10 level before retreating slightly. Ultimately, if the aim of Chair Powell going into the meeting had been to avoid moving markets, then his more balanced tone at this conference did not help the cause.

On the whole, while we don’t think Chair Powell’s tone at today’s press conference is suggestive of an immediate pause from the Federal Reserve, or an endorsement that policy easing in the second half of the year is definitely in scope for the FOMC, the more cautious stance and obvious preference for keeping the level of financial conditions tight does compound our view that the Fed is likely to undershoot their previous projected terminal rate in order to sustain the duration of restrictive policy. We continue to forecast a terminal rate of 4.75-5%, which we believe will be reached at the March meeting.

A hawkish ECB coincides with interpretations of a more dovish Fed to narrow rate differentials and send EURUSD as high as 1.10

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