The Fed pauses on a pivot

It was no real shock that the Fed decided that this was not a good time to pivot to a more dovish monetary policy regime. Afterall, inflation is still running hot, core inflation is at its highest level since the 1980s, and the US labour market shows no sign of slowing down yet. The September JOLTs survey showed an increase in job openings, and the number of unemployed people per job opening is at an historically low level. Non-Farm Payrolls are expected to show growth of nearly 200k for last month, which does not suggest an economy in trouble. Even so, the Federal Reserve had to acknowledge the huge amount of tightening that it has already done: 300 basis points in the last 4 meetings, interest rates in the US were 0% in March. The Fed managed this with aplomb. It mentioned the “cumulative tightening” that has happened already this year, and how it expected this to have a lagged effect on the economy and the labour market. However, to balance any dovish tones from the “cumulative tightening” statement, Jerome Powell clearly stated that now is not the time to stop hiking interest rates and that the terminal rate would be higher than what the market currently expects.

Rushing to price in a higher Fed Funds terminal rate  

This seemingly innocuous meeting: the Fed hiked by 75bps as expected, there was no dot plot or economic projections, turned out to be very important indeed. The market rushed to price in a higher terminal rate straight away, as the Fed must have anticipated. US interest rates are now expected to peak in May or June of 2023, at just over 5%. Interest rates are expected to fall very slowly from there, with current interest rate expectations for the Fed at 4.69% for January 2024, which is a higher level than the current Fed Funds rate. Thus, far from the dovish pivot, Wednesday’s Fed meeting confirmed that rates will move higher and stay higher for longer. The reaction in other financial markets was swift. After initially rallying ahead of the meeting, the S&P 500 dropped more than 2.5%, although it has eroded some of these losses in after-hours trading. The dollar index, which is moving inversely to stocks in the current trading environment, initially fell on the news, however, when the markets realised that Powell was expressing hawkish sentiments in his press conference, the dollar index quickly reversed course, and is currently trading at its highest level since 25th October. 2-year Treasury yields jumped 15 basis points to 4.6%, and 10-year yields jumped 10 basis points, as the latest Fed meeting pushed the US yield curve further into inversion territory. These moves all suggest that the market has put to bed the idea of a Fed pivot for now.

Waiting for a strong jobs report

Looking ahead, the focus will be on the US labour market data that will be released on Friday. The market is expecting a fairly healthy report, with approx. 200k jobs expected to have been created in the non-farm sector last month. The bias is for a stronger number, after a larger than expected reading for the ADP report, a stronger JOLTs job openings survey for September and a strong employment component of the ISM index for October. Unless we get a very large negative surprise, then we think that the market will continue to act on the higher terminal rate narrative for the US Fed Funds rate.

The outlook for tech: watching the US terminal rate

Overall, the US terminal rate is the key driver for global markets right now. If the market starts to price in the prospect of US rates peaking above 5%, will that be what finally tames inflation and causes the economy to fall? A higher terminal rate is bad for stocks, especially tech stocks, which could fall further. We continue to prefer energy over tech for the medium term, as the relative valuations (tech is still more expensive than energy stocks) support more tech weakness vs energy shares, and the inflationary backdrop also favours commodities. It is also worth noting that if Thursday’s FOMC meeting causes another leg higher in the USD, then this could lead to pain for emerging markets and more FX market volatility. USD/JPY has been extremely volatile in the aftermath of this FOMC meeting, after initially falling on the decision, USD/JPY is now climbing back towards 148.0. As we get closer to 150, intervention risk from the BOJ to try and shore up the yen increases. Thus, the impact of this Fed meeting could spread far and wide.