Fed Recap:

by Michael P. Reinking, CFA & Eric Criscuolo

As widely expected, the Federal Reserve cut rates by 25bps and announced the end of the balance sheet runoff (QT) starting on December 1st. The statement was largely unchanged. The language around the labor market suggested that based on the “available data” that job growth continued to slow. Inflation was once again described as “somewhat elevated”. The only surprise in the statement was that there were two dissents on opposite ends of the spectrum. Stephen Miran, a.k.a. the Dissident DOT, once again called for a 50bps cut while Jeffrey Schmid preferred to leave rates unchanged. If you paid attention to the Summary of Economic Projections or have listened to any of the recent speeches, you could argue this wasn’t a surprise at all. The market reaction ahead of the press conference was muted with equities virtually unchanged though yields did tick up a couple of basis points.

The Fed also announced the end of its balance sheet run-off, as expected. Powell’s opening statement noted that “Our long-stated plan has been to stop balance sheet runoff when reserves are somewhat above the level we judge consistent with ample reserve conditions. Signs have clearly emerged that we have reached that standard.”  Maturing Treasury principal was being redeemed up to an already-low $5B/month cap, with the balance being rolled over into new Treasuries. Beginning December 1, the Fed will roll over all principal payments from its Treasury holdings. In addition, maturing mortgage-backed securities (MBS) principal will be reinvested into Treasury bills. This will bring the weighted average maturity of the Fed’s securities portfolio more inline with that of the outstanding stock of Treasury securities. The declining level of bank reserves was becoming a greater focus for the Fed and the cadre of financial system plumbers, as was the market’s ability to finance the ever-expanding issuance of Treasuries via repo. The rise in SOFR rates (repo) and the effective fed funds rate (EFFR), and the related usage of the Fed’s Standing Repo Facility (see below) have been among the signs that Powell referenced. SOMA manager Robet Perli and Dallas Fed President Lorrie Logan could be two officials who provide greater analysis of this topic after the blackout window ends. 

It was pretty clear that Chair Powell had an agenda heading into the press conference, maintaing some optionality. His commentary around the economy during his prepared remarks were pretty consistent. However, he made sure to highlight that the path of monetary policy was not on a preset course saying a cut in December was “not a foregone conclusion, far from it”. This quickly sent the S&P 500 down ~1%, just a touch below yesterday’s low, while yields jumped 5bps. Outside of the dissents, he suggested there was broad support for today’s cut but the bigger debate is about how to move forward. Those “decidely differeing views” center around assumptions as to where the neutral rate is. The Chairman once again categorized the current policy rate as “modestly restrictive” but after two cuts the rate is “now in the range of many estimates of neutral” which he repeatedly suggested is a reason for the Fed to move forward with caution, using the driving through the fog analogy again.

Not surprisingly the impact of the government shutdown was a popular topic. The Chairman highlighted the Committee can still rely on the state level claims, surveys, the Beige Book and other private sector data. Based on that incoming data, the Committee is seeing a gradual cooling of the labor market with demand falling a little more than supply. He did acknowledge the recent pickup in layoff announcements but noted this was not yet showing up.

 In terms of inflation he acklowledged that inflation remains above target but didn’t seem overly concerned. He noted that excluding the impact of tariffs on goods, which he once again categorized as one-time, that inflation was not far from the Fed’s 2% target. The goods inflation was expected to continue for a while but he noted the decline in shelter components was offsetting some of that.

The Chairman tried to dodge questions about valuation and bubbles but noted the difference between now and the 90’s is that the companies driving investment are very profitable and noted that monetary policy would have very little impact on those investment decisions.

By the end of the day the S&P 500 recouped about half of that 1% drop, ending the session around unchanged. However, as markets throttled back the expectations for rate cuts it reinforced the rotational flows that have been happening throughout this week. Tech and the AI-complex rallied while the equal weight version of the S&P 500 and small/mid cap indices ended near the lows of the session off >1%, about a 2% intraday decline.  

Coming into today’s session the market had a ~90% probability of a rate cut in December that got cut to about 65%. Yields moved up about 10bps across the curve while the USD ended up ~0.5% closing around $99. Precious metals reversed earlier gains with gold breaking back below 4k. The crypto complex had been pulling back throughout the session with Bitcoin trading around 111k.  

Tomorrow is setting up to be a big day. Investors will have a little time to allow the shift in messaging to set in but this evening the highly anticipated meeting between President Trump/Xi is set to take place, which will set the tone for tomorrow. There are also rate decisions from the Bank of Japan and the ECB. After the close the first of the mega cap tech earnings have started to hit the tape along with a slew of other companies. The response to those earnings has been mixed (GOOG +5%, META -7% and MSFT -1%).

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