Investors could have read too much into an apparent hint that the Federal Reserve will slow its interest rate hiking plan, according to one commentator, who argued that yesterday’s market rally on the back of this could have been mis-guided.
Speaking at the Economic Club in New York, Federal Reserve chair Jerome Powell said interest rates are "just below" neutral, suggesting that they are at a level that neither hampers or accelerates economic growth.
This sits in stark contrast to comments from Powell just a month ago, when he said the central bank had a “long way” to go before interest rates were at a neutral level. The chair has been under frequent attack from US president Donald Trump for pushing up rates.
The Federal Reserve has been gradually lifting interest rates since Powell was appointed as chair in February 2018. The benchmark rate has been raised three times this year and the Federal Open Market Committee (FOMC) was expected to do so again at its next meeting in December.
Performance of S&P 500 on 28 Nov 2018
Source: Google Finance
“Interest rates are still low by historical standards and they remain just below the broad range of estimates of the level that would be neutral for the economy – that is, neither speeding up nor slowing down growth,” Powell said.
“My FOMC colleagues and I, as well as many private-sector economists, are forecasting continued solid growth, low unemployment, and inflation near 2 per cent.”
The Fed chair also said “there is no pre-set policy path” and that the central bank would be “paying very close attention to what incoming economic and financial data are telling us”.
The S&P 500 rallied sharply after the speech, gaining 2.3 per cent in yesterday’s session. The cheer also spread to Asia markets, while the FTSE 100 rallied on the comments when it opened this morning.
Neil Wilson, chief market analyst at Markets.com, said: “If you were looking for a trigger for a December rally in equities, we got it last night from the Federal Reserve. The Dow surged more than 600 points after Fed chair Jerome Powell said rates were currently ‘just below’ neutral, barely two months after he said interest rates were ‘a long way’ from neutral.
“Powell’s statement on the neutral rate was taken as a dovish assertion by markets and in many ways you could say the Fed chair just turned Santa for equity investors.
“If a December pop for equities, or Santa Rally, were going to occur then a more easy Fed will do it. The softer language from the Fed will be heard loud and clear by equity markets as a sign it's aware of the risks of tightening too quickly.”
Powell’s speech did indeed point out that the central bank is mindful of the risks of tightening monetary policy too quickly. The chair said the Fed’s gradual pace of interest rate hikes is designed to balance the risk of moving too quickly and choking off growth against the danger that keep rates too low for too long could lead to higher inflation or destabilising financial imbalances.
The Federal Reserve’s ‘dot plot’ – Sep 2018
Source: Federal Reserve. FOMC participants’ assessments of appropriate monetary policy: Midpoint of target range or target level for the federal funds rate
However, Wilson added: “Of course, there is another way to read it. In some ways this was about correcting a pretty basic error when he said rates are long way from neutral. This off-the-cuff comment sparked the equity sell-off from which markets are still struggling to recover. But the macroeconomic indicators have softened. There are signs of slowing growth, both in US and globally that the Fed cannot ignore.”
Pantheon Macroeconomics chief economist Ian Shepherdson warned that the market could have made too an optimistic reading of Powell’s comments and cautioned investors against anticipating a much more dovish Fed.
“Chair Powell’s remarks at the NY Economic Club have flattened the curve, with most of the commentary focused on his statement that rates are ‘just below’ neutral range. But this is misleading; what the chair actually said was that rates are ‘just below the broad range of estimates of the level that would be neutral’,” Shepherdson said.
The broad range of estimates of neutral in the Federal Reserve’s September forecasts was 2.5 to 3.5 per cent, while the target range for the funds rate now is 2 to 2.25 per cent.
“So, the top of the target range is only one hike away from the bottom end of the range, but it remains three hikes from the middle of the range and five from the top. Moreover, estimates of the neutral rate are likely to rise over the next year on the back of stronger productivity growth,” Shepherdson continued.
“Powell’s own views might well be leaning to the dovish side, but he was not, in our view, signalling any impending change in the FOMC’s dots. As always, the Fed ultimately will do what the data tell them to do and we think the 3.7 per cent and falling unemployment rate leaves policymakers very little room for manoeuvre.”