• Financial markets remained volatile in November on concerns of tighter monetary policies, U.S./China trade relations, and slowing global growth
  • Fed Chair Powell appeased the markets by tempering the perceived hawkishness of his October comments
  • The minutes of the November FOMC meeting foreshadowed an adjustment to the Fed’s forward guidance in the December statement, placing a greater emphasis on data dependency; another technical adjustment to IOER is also likely in December

Broad market volatility remained elevated in November amid ongoing concerns of tighter monetary policy, U.S./China relations, and the slowdown in global growth that may result from these matters. The U.S. economy continues to grow at an above trend rate, bolstered by tight labor markets and strong consumer spending. At the same time, the current expansion is now at 113 months, the second longest streak since World War 2 and close to besting the 1990s expansion at 120 months. As we have repeated several times, business cycles do not run on clocks, but it is natural for market participants to expect a cycle shift (or at least deceleration) soon. The current expansion received a great deal of support from massive Fed accommodation (0% rates and asset purchases) and, more recently, fiscal stimulus (tax cuts and deficit spending). The former is now reversing and moving toward neutral, and the benefits of the latter are beginning to fade, particularly with looming trade issues threatening to offset stimulus efforts. As such, the market’s focus on Fed policy and trade should not be surprising.

For much of November, there had been a particular focus on Fed Chair Jerome Powell’s comments from October 3, which we referenced in last month’s commentary. In the speech, Powell opined that the current policy rate is “a long way from neutral probably.” The market seemingly ignored the qualifier at the end of that statement and perceived it to be a hawkish shift from the Fed leader. Fedspeak since the September FOMC meeting had been fairly consistent, suggesting that 1) gradual policy normalization remains appropriate, 2) policy rates may move beyond neutral (into restrictive territory), and 3) policymakers don’t know with certainty what the neutral policy rate is. While the honesty regarding neutral rate certainty (or lack thereof) that Powell and his colleagues shared in October was refreshing, markets don’t always respond well to such ambiguity. As such, there was a growing expectation for Powell to temper his October 3 comments. On November 28, Powell effectively did so in a speech before the Economic Club of New York. “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,” said Powell. The “just below” neutral language was enough to spark a 2.3% rally in the S&P 500, and front-end Treasury yields fell 2-3 bps (curve 3 bps steeper). While the markets responded positively to Powell’s comments, the differences between what he said on 10/3 and 11/28 were more nuanced.

The September Fed projections for the fed funds rate showed a median forecast of 3% for the long-run rate (2.5% - 3.5% range), which is considered participants’ current forecast for the neutral rate. With the current target rate at 2.25%, a “just below” neutral doesn’t appear to be a significant shift in guidance. It’s more likely an easy appeasement from the Fed leader given his emphasis in prior speeches that the neutral rate isn’t known in real time with any certainty anyway. To be clear, Fed leaders have to be careful with their language, but Powell’s 11/28 comments didn’t really change the narrative enough to put his colleagues “in a box” at future meetings. With regards to market pricing versus the Fed’s forward guidance, the market forward rates are still lagging the Fed, which is not atypical in the mature phases of a tightening cycle. Median Fed projections call for 4 rate hikes over the next year, while the market is effectively priced for 2 hikes.

The minutes of the November FOMC meeting, released on November 30, did suggest a dovish moderation in the Fed’s guidance could be forthcoming. While participants maintained a positive economic outlook and desire for continued “gradual” normalization, the minutes conveyed an emphasis from all participants to base policy decisions on incoming data. More specifically, they may remove the language from the official statement that expresses expectations for “further gradual increases” in the funds rate and replace it with an emphasis on data dependency. In other words, the Fed is effectively saying ‘don’t pay so much attention to the dots’. The minutes also foreshadowed another downward technical adjustment to the interest on excess reserves (IOER) rate in December (e.g., IOER is increased by 20 bps while the target range rises 25 bps)...


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