The cut the federal funds rate (FFR) by 25bps yesterday as widely expected. We expected it as well, though we still believe that the now 75bps cut in the FFR since September 18 is too much, too soon because both the economy and the labor market remain strong. In his yesterday, Fed Chair Jerome Powell acknowledged several times that both remain solid. He said that they are “in a good place.”
Nevertheless, he stated a few times that he and his colleagues on the FOMC believe that monetary policy remains restrictive since the FFR is still above its mystical “neutral” level. He did not explain, nor did any reporter ask him to explain, how they know that monetary policy is restrictive if the economy is doing so well when he also said that economic growth could be even stronger next year!
In his opening remarks, he said,
“We know that reducing policy restraint too quickly could hinder progress on inflation. At the same time, reducing policy restraint too slowly could unduly weaken economic activity and employment.”
Notice that he is implying that the FOMC is committed to lowering rates, the only question is how fast. He did say that given the strength of the economy, there’s no rush to lower the FFR. So at his latest presser, Powell stuck to his ultra dovish pivot which he first signaled in his August 23 Jackson Hole speech: The Fed will be cutting interest rates for the foreseeable future.
Powell said the Fed is trying to find the middle path between the risk of cutting the FFR too quickly thus undermining progress on inflation, or cutting too slowly and allowing the labor market to weaken too much. In either case, rates are being lowered. The only question is how quickly.
We were surprised that the vote to cut the FFR was unanimous yesterday. Governor Michelle Bowman dissented in the September 18 FOMC meeting. Powell acknowledged that the economic numbers since then have been stronger than expected. One might question why an additional rate cut was needed if the economy is in fact in better shape yesterday than it was at the Fed’s last meeting. What’s the rush, if there is supposed to be no rush?
Powell provided a mixed message on the labor market. Several times he said it was strong. One time he said that the labor market is less tight yesterday than it was in 2019 before the pandemic.
Yesterday’s market action was muddled by the big reaction to the red-wave election results. Nonetheless, the rose 0.7% to a new record high of 5,973. Combining easier monetary policy with still very stimulative fiscal policy in an already strong economy is likely to push stock prices higher and increase the possibility of a meltup.
The bond yield fell more than 10bps yesterday, reversing some of the rise. The question is whether the bond market will continue to tighten credit conditions as it has since the September 18 FFR cut.
Powell was asked a couple of times about the backup in bond yields. He explained that the 75bps rise in Treasury yields since the FOMC cut the FFR by 50bps was mostly a result of stronger economic growth and diminished recession risk. He minimized the impact of higher inflation expectations. But the market’s inflation expectations, based on the difference between nominal Treasury yields and TIPS yields, have risen.