In the FOMC statement yesterday, markets got a taste of something new and interpreted it in a dovish light as the Fed noted that:
“In determining the pace of future increases in the target range, the committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation and economic and financial developments.”
Putting into context that markets were waiting to capitalise on any slip up by the Fed, this was enough for risk trades to rally and the dollar slumped in reaction to the statement. However, out comes Powell and everything turns back 180°. What exactly did Powell say in his press conference?
- The terminal rate may be higher than previously thought i.e. if we were to have another set of dot plots yesterday, they would have been higher – even if the outlook is still very uncertain
- It is “very premature to be thinking about pausing, very premature..”, even if there is any mention of looking into the lags in which monetary policy will take effect on the economy and inflation
Those were two critical points, adding to the notion that Powell hinted that the focus remains on how high rates have to go and how long does the Fed need to keep them there in order to stifle inflation pressures. In other words, it is better to do too much than to do too little in the tightening cycle and the Fed’s resolve in delivering on that remains unwavering.
As Adam pointed out here, it is rather clear that Powell will not accept markets thinking otherwise. I’ve pointed out yesterday how there is much at stake for the Fed, especially in terms of credibility. You can check out Powell’s word-for-word response to finding out that “stocks and bonds are reacting positively so far”. It comes at around 38:43 in the video below:
So, where do we go from here?
Ultimately, this will continue to keep the dollar in a strong position so long as economic data supports the Fed’s resolve. Inflation and labour market data will remain key, so this week’s non-farm payrolls report will be another big one to watch.
As for broader market sentiment, it’s going to be a tricky one to navigate but on the balance of things, we might expect another leg lower. In the case of the S&P 500, the fact that it is being rejected at the 100-day moving average makes it much worse – adding to the sustained pattern of lower highs, lower lows: