It's a subtle shift but enough to get markets excited as equities rallied hard, with the Nasdaq seeing its best day in over 2 years in a 4% rally. While risk assets soared, the dollar stumbled but are we actually getting that close to a pivot by the Fed?
Let's try and dissect the quotes from Powell yesterday. On the neutral rate, he made mention that:
"We would move expeditiously to get to the range of neutral and I think we've done that now.. we're at 2.25% to 2.50% and that is right in the range of neutral."
"Now that we're at neutral, at some point it would be appropriate to slow down. We've been frontloading these very large interest rate increases and now we're getting close to where we need to be. But we haven't made a decision on that."
That is pretty much the first key step in the inflation battle i.e. getting to neutral. The bases are now loaded and the Fed needs to seal the deal with a home run. There is going to be more rate hikes to follow, so one must not get too hasty in anticipating that the Fed is going to be sending a different message any time soon.
Powell did acknowledge some slowing in the economy but he talked a lot about how things are "moderating". That remains the message even as recession risks are on the rise. I mean, it's not like he has much of a choice as the Fed is still tightening and is making inflation its number one priority at the moment.
He even deflected a question about rate cuts by saying that:
"It is very hard to say with any confidence what the economy will be doing in 6-12 months and the monetary policy response to that. There is so much uncertainty, these are not normal times."
However, the big takeaway from yesterday is when Powell mentioned this with regards to the September FOMC meeting:
"We're going to be looking at all of those things (activity, labour market, inflation) and where does it really need to be. We're going to watch the data and evolving outlook very carefully and factor in everything in September about what to do. I'm not going to provide specific guidance on what that might be. We're going to be guided by the data. We might do another unusually large interest rate increase but that is not a decision that we have made at all. We're going to be guided by the data."
He didn't specifically mention that the Fed is moving to a meeting-by-meeting basis or that forward guidance is dead à la the ECB. But the message is that the Fed is going to be more data-dependent now that: 1) they have reached neutral territory, 2) the economy is slowing, 3) they have frontloaded rate hikes and are waiting for its effects to be felt.
That's enough for markets to believe that the Fed is angling towards a pivot. Technically, that is correct but I see this as the Fed taking one smaller step in the tightening cycle rather than a step backwards. It is a subtle difference but risk trades will take what they can get at this point.
That being said, we're not out of the woods just yet. Powell outlined that the terminal rate may settle around 3.25% to 3.50% and that is precisely where markets are pricing in the Fed to go to at the moment. The question now is what happens when that is not enough to rein in inflation and the Fed is unyielding in its resolve to tackle that?
That would mean the pivot gets kicked down the road and the timeline drag isn't quite an optimistic development for risk trades surely.
I think we won't get a straightforward "this reaction in the market will be short-lived" kind of trade at the moment with risk and the dollar but perhaps this will give dip buyers and dollar bears some ammunition to work with. I would wager that it is not enough to produce any major turnaround in market trends but at least now, there is some scope for the recent market conviction to ease slightly.
