Fed Recap:

by Michael P. Reinking, CFA - Sr. Market Strategist

     Patricia Medina - Market Strategy Analyst

As widely expected, the Federal Reserve lowered the federal funds rate by 0.25% to a range of 4.25% - 4.5%. There were minimal changes to the statement. The description of labor market conditions and inflation progress were unchanged from last meeting however, forward guidance evolved in a hawkish way with the Committee adding “the extent and timing of additional adjustments” to the target. This clearly put the prospect of the Committee holding rates steady on the table. In addition, there was a dissent by Beth Hammack who took her post back in August.

The focus quickly shifted to the Summary of Economic Projections which also carried some hawkish messaging. Since the 2024 projections are really just a mark to market, I’ll focus on the 2025 projections and beyond.  GDP estimates moved up a tenth to 2.1% which is a moderation from current levels. The unemployment rate was revised slightly lower to 4.3% for the next three years.

The first hawkish data point was the increase in projections for inflation from September. Headline PCE is expected to accelerate being revised up to 2.5% from 2.1%. Core PCE was also revised higher to 2.5% from 2.2%, pointing to further progress from the current 2.8% level but is not expected to hit the Fed’s target until 2027. During the press conference Chair Powell did provide some context to this increase saying that some officials had begun to incorporate potential policy changes into their forecast adding to some of the uncertainty in reading this data. Before moving to the DOTS, I just wanted to highlight that at the end of last year the 2024 estimates within the SEP were for 1.4% GDP, 2.4% Core PCE and a Fed Funds Rate of 4.6%, so growth was stronger and inflation remained stickier than expected yet rates are lower - so it’s hard to put too much weight in these estimates.

The DOTS were also hawkish. The 2024 DOT was interesting in that 4 of the 19 officials did not pencil in a rate cut today suggesting that Hammack wasn’t the only official pushing back in the room, something Chair Powell later acknowledged saying that today’s decision “was a closer call”. Projections for the next two years were revised higher pointing to only 2 rate cuts in both 2025 and 2026 and an additional one in 2027. This was largely in line with what markets were pricing in ahead of the meeting but on the hawkish end of the scale. The Longer run rate also continued to move higher hitting 3%. There was also a big clue provided in the back of today’s SEP with the balance of risks for unemployment more balanced but around two thirds of the Committee shifting their view to the balance of risk for inflation moving to weighted to the upside. 

In response to the supplementary documents the S&P fell ~1% as Treasury yields jumped over 10bps across the curve. I thought the documentation was largely in line with what markets were pricing in ahead of today’s meeting though did highlight the dissension in the room and that there was more concern about inflation upside than had previously been discussed.

Moving to the press conference after his prepared remarks which were consistent with recent communication some of the highlights of the meeting happened very early on. In response to the first question the Chairman said that today’s decision was a close call. He went on to explain that decision to cut, pointing to the moderation in the labor market and said that inflation was broadly moving as they hoped pointing to some of the silver linings in the recent inflation data, we’ve discussed - the decline in the OER and non-housing services inflation - but did note that the balance of risks had shifted. Early on he also explained the additional language in the statement saying that it was meant to signal that “we are at or near the point to slow further adjustments”.

Discussing the reduction of rate cuts for next year he made it clear that this was largely a reflection of the increased inflation risk and uncertainty. this is when he acknowledged that some officials were starting to incorporate the potential policy impacts into their projections. Howard Schneider of Reuters tried to pin the Chairman down on the idea that the uncertainty was driven by the election results to which the Chairman ultimately said with the hotter inflation starting at the end of Q3 that their inflation target has, “kind of fallen apart as we’ve approached the end of the year”. However, the nuance about the incoming administration seems to have gotten some attention and could draw some ire down the road.

Another interesting moment during the press conference on this topic was the reporter from the AP pointing back to the 2018 Teal Book. The Chairman pointed directly back to the scenario analysis and the see-through paragraph which said that the conditions for that to occur would be “anchored inflation expectations and the passthrough of cost shocks into inflation being relatively short lived”. It is clear that the Committee is doing their homework but in theory this was a dovish readthrough.

Many of the rest of the sound bites that we heard today in the press conference were similar to previous communication - that with a 100bps of cuts under their belt that rates are now less restrictive, and they should proceed with caution - though today’s analogy was about driving on a foggy night instead of a boat pulling into port. I had to go back through the press conference to see if there was just something I was missing in terms of the market response, but I think part of the problem was that there was quite a bit of mixed messaging, which didn’t necessarily foot with the data.

Treasury yields continued to move slightly higher during the press conference ending the session up >10bps across the curve while the USD is up >1% to ~$108, both of which are retesting their post-election highs. The equity market weakness accelerated into the close with headlines coming from Washington related about the difficulty in getting a stopgap funding bill through Congress not helping sentiment, in that this highlights the slim margins for the GOP to push across the incoming President’s agenda.

The weakness was broad-based with major indices cutting right through technical support levels. The S&P 500 fell  3% breaking below its 50d ma. The breadth beneath the surface has been terrible for weeks, but today the rug got pulled from underneath the mega-cap tech names as well, with the NYSE FANG+ index falling over 4%. This was the 10th consecutive down day for the Dow Jones Industrial Average extending its losing streak to 10 days the longest since 1974. Today's selloff has pretty much wiped out all of the post election gains across the board.

There was also a surge in the VIX which has moved into the high twenties, which along with the breaking of technical levels leads to systematic de-risking. The fact that it is options expiration is likely exacerbating some of this weakness as well. The consensus view (and mine included) was that today’s meeting would be in line with market expectations, which for the most part it was, and that it would act as the clearing event for markets to resume to the upside. The message may have been a bit more hawkish and it seems like traders did take this as a clearing event, but just to take risk off the pad heading into a period of time where liquidity dries up - though it has historically been a very strong period for stocks especially in up years.

There are a couple more rate decisions to come in the next twenty four hours including the BOJ, BoE and Sweden’s Riksbank. The guidance from Micron and Lennar earnings won’t help sentiment either. There are a couple of earnings reports that will get some attention ahead of the open as well as initial claims data.

Pre-Market: ACN, APOG, CCL, CSPI, CTAS, DRI, FDS, KMX, OTLK, PAYX

After-Market: AIR, AVO, BB, FDX, ISSC, NKE, RFIL, SCHL

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