The Federal Reserve policy committee took a big hawkish shift on Wednesday, dimming hopes for a quick shift to rate cuts in 2024. After the Fed meeting ended with no change in the key policy rate, as expected, the S&P 500 traded modestly lower. But stocks lost their footing late in the day as market-based interest rates on government bonds jumped.
The hawkish shift in the Fed outlook came as new projections signaled growing confidence in a soft landing. The jobless rate is now seen rising only to 4.1% by the end of next year, down from June's projection of 4.5%.
Asked about the rise in Treasury yields, which have been hitting levels last seen before the 2008 financial crisis, Fed chair Jerome Powell said: "It's not because of inflation."
Powell highlighted "more supply of Treasuries" and stronger growth as partial explanations. Part of that extra supply comes from Fed quantitative tightening, the unloading of government-backed mortgage securities and Treasuries that the central bank bought early in the pandemic to boost financial market liquidity. The Fed is letting up to $95 billion in bonds run off its balance sheet each month.
Fed Chair Powell
Although the Fed projections still point to one more quarter-point rate hike this year, Powell appears in no rush to hike again. He indicated the Fed can exercise patience, having raised interest rates so far already. That could be interpreted as a signal a Nov. 1 hike is unlikely.
"We are in a position to proceed carefully," Powell said.
Powell didn't sound particularly hawkish, noting "good inflation readings for the last three months." He added that the latest jobs report showed "what we want to see." But the Fed would like to see at least six months of data to be confident that inflation is coming down sustainably.
The subtext is that the Fed doesn't have much conviction one way or another about where the economy, inflation and interest rates are headed.
"Growth has come in stronger and that's required higher rates" in the Fed's projections, Powell said. Yet he also acknowledged a number of factors that might lead economic growth to slow, including a resumption of student loan payments, higher interest rates, the United Auto Workers strike and a potential government shutdown. Higher energy prices also could have a negative impact on spending, he said.
Fed Rate-Hike Projections
The new batch of quarterly projections showed that 12 of 19 committee members anticipate one further quarter-point rate hike this year, with the other seven believing no hike will be needed. That would raise the federal funds rate to about 5.625%, the midpoint of a target range of 5.5% to 5.75%.
The split between hawks and doves changed little from June when 12 of 18 committee members expected one further hike from current levels.
Since then, Adriana Kugler joined the Fed board of governors, so the new total reflects one extra projection.
For 2024, the median year-end projection for the Fed's key rate jumped to 5.1% from 4.6% in June. Back in June, eight members had expected the Fed's key rate to end at 4.875% or higher; 2 members expected a 4.625% rate; and 8 dovish members expected the Fed's key rate to fall to 4.375% or lower.
Here's how much opinions shifted in the September projections: Now, 10 members see a year-end rate of at least 5.125%. Another four members see a 4.875% rate; and 5 members expect a year-end rate of no more than 4.625%.
The odd thing is that the Fed raised its estimate of the year-end federal funds rate a half-point while holding its estimate of core PCE inflation at 2.6% in 2024. That means real interest rates would be significantly higher under the projected policy than the Fed envisioned in June projections.
Fed Rate-Hike Odds
After the Fed meeting, markets were pricing in 28% odds of a quarter-point rate hike on Nov. 1, down from 30% on Tuesday. Odds of a rate hike by the Dec. 13 meeting rise to 47%, up from 41% a day ago.
That suggests investors are taking Fed projections with a grain of salt. Markets are now pricing in a year-end 2024 rate of 4.8%.
S&P 500
The S&P 500 closed down 0.9%, falling further below its 50-day moving average.
The rising 10-year Treasury yield, which acts as a headwind to stock valuations as well as household spending on big-ticket items, continues to cause trouble. On Tuesday, the 10-year yield hit a new 15-year high of nearly 4.37%. The yield settled back to around 4.35% after the Fed meeting, then charged to 4.4% late in the day.
Be sure to read IBD's The Big Picture every day to stay in sync with the market direction and what it means for your trading decisions.
