(Bloomberg) — Traders on Wall Street cheered Wednesday as Federal Reserve Chairman Jerome Powell signaled that he did not expect any imminent interest rate hikes despite inflationary pressures. The celebration didn’t last long.
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For a brief period, U.S. stocks rose sharply, sparking the biggest post-policy meeting rally since December, while Treasury yields across all maturities fell more than 10 basis points. The relief trade began when Powell told reporters: “It is unlikely that the next rate hike will be a hike.”
The problem is that Powell didn’t explicitly signal a rate cut this year either, saying it would likely take longer for central bankers to gain enough confidence in the downward trend in inflation to consider easing monetary policy. That reality check triggered an abrupt turnaround in stocks, which ended the day in the red. Treasury yields moderated their decline somewhat, with policy-sensitive two-year yields remaining below the 5 percent threshold – but not by much.
“Powell has made it clear that the hurdle to raising interest rates is incredibly high,” said Michael de Pass, global head of rates trading at Citadel Securities. “Ultimately, they find the level of tariffs to be restrictive, that cannot be denied. Are they restrictive enough and how long will it take for them to penetrate the economy are the questions now.”
The fact that the market reacted at all to the idea that rate hikes were likely off the table shows how much sentiment has changed since the start of the year, when the consensus was calling for multiple rate cuts and an expected steady downward trend in inflation. There were hardly any forecasts for higher interest rates.
Lately, however, investors—particularly in the Treasury world—have had reason to worry about a possible hawkish policy shift from the Fed as the U.S. economy has remained resilient, job creation is surging and inflation is proving harder to tame. Bond traders have cut the prospect of interest rate cuts to just over one from six quarter points in early January.
A selloff in stocks and bonds in April that pushed two-year Treasury yields above 5% and sent the S&P 500 index plunging to its worst monthly loss since October highlighted the tension building ahead of this week’s Federal Open Market Committee meeting. And potentially crucial data is still to come: Friday’s April jobs report is expected to show robust job growth, while more inflation reports are expected in the coming weeks. Central bankers have to weigh everything.
“The FOMC appeared careful not to let the market stray too far from its base case of solid growth, persistent inflation and the intention of a cut later this year,” Citigroup Inc. strategists led by Stuart wrote Kaiser in a note, referring to politics. Establishment of the Federal Open Market Committee. “The result was a great round-trip trading day.”
Powell highlighted what is at stake for investors when he said that while he believes current interest rate policy “is restrictive and we expect it will be sufficiently restrictive over time,” will be a question that the data will have to answer.”
Although Powell acknowledged that there has been no recent progress toward meeting the Fed’s 2% inflation target this year, his suggestion that cuts were more likely than increases was enough to calm the market, at least initially. Whether this justifies a sustained stock rally is another question.
What Bloomberg strategists say…
Powell: Rate cuts before the end of the year are still on the table. Bottom line: Interest rates are capped, but the Fed will ease rates if the unemployment rate rises much further from here. The Fed has an easing bias.”
— Edward Harrison, Markets Live Blog Contributor
“I was more confused when I figured out what Powell said to make stocks rise so much,” said Steve Sosnick, chief strategist at Interactive Brokers. “Sure he said no rate hikes were necessary and downplayed fears of stagflation, but that wasn’t worth a major speculative rally.”
As for the longevity of the recent bond rally, Citadel’s de Pass warned that while the recovery “makes sense,” the market is nearing its limits.
“With the market well past the lows in yields, it has already run out of steam,” he said. “Given that we are in a situation of data dependence, the market is likely to find it difficult to function even more strongly.”
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