Powell, usually dovish, suddenly turned hawkish, and the market believes this is a "prelude to a big event"...
Bond traders continue to bet on the Fed cutting interest rates, even as Fed's counterattacks failed to shake their confidence.
On Thursday, Fed policy makers held interest rates steady at their highest level in over 20 years and expect a rate cut of only 25 basis points before year-end, about half of what the market had expected.
At the post-meeting press conference, Powell insisted that the Fed was not in a hurry to change policy, but should wait for more evidence that its efforts to fight inflation are heading in the right direction, despite the long-awaited announcement of CPI data earlier that excited traders.
After the Fed meeting, the market essentially maintained its gains, downplaying Powell's hawkish remarks and suggesting that it was a signal that the Fed did not want to be trapped by previous remarks. Michael de Pass, global head of rates trading at Citadel Securities, said:
"Powell clearly wants to keep options open, he wants to appear more even-handed, and make sure he's not fanning the flames after inflation drops below expectations."
Of course, in recent years the market has been too eager and expected the Fed's policy adjustments to come, but when the Fed insists on its own trajectory, painful adjustments time after time catch the market off guard.
However, policymakers have made it clear that once they are confident that inflation will easily fall back to their 2% target, they are ready to start lowering rates.
US inflation is still rising at a pace higher than that level, and Powell said that it proves the Fed's restrictive policy stance is reasonable. But he also said that the labor market is no longer overheating and is back to where it was before the pandemic, emphasizing that the Fed is watching for downside risks to economic slowing. "We are seeing what we hoped to see, which is a gradual cooling of demand."
Powell added that rates will eventually need to come down to continue to support the economy, but it is not necessary at the moment. He said, "We need to see where the data is pointing us."
Strategist Cameron Crise said, "Well below expectations CPI sparked an asset-buying frenzy, which makes sense given the unexpected shift in key inflation indicators. However, on the surface, the dot plot and economic forecasts are quite hawkish, with inflation forecasts being raised, and the median federal funds rate holding steady at 5.125% in 2024. But in reality, the hawkishness of the dot plot is less than in previous times. If the inflation trajectory remains subdued, coupled with the prospect of another tilt towards dovishness, the market reaction to the CPI seems to be correct."
CPI data is seen by traders as an encouraging sign, as they are plagued by a series of higher-than-expected inflation data at the beginning of the year and a sell-off in the bond market triggered by a surge in non-farm payrolls last Friday.
Wednesday's report showed that core inflation rose 3.4% year-on-year, the lowest increase since April 2021. This prompted futures traders to increase their bets that the Fed would cut rates twice this year and saw a high probability of the first cut in September.
Fixed-income manager Akira Takei at Tokyo's Asset Management One Co. said, "Once the job market shows a rapid deterioration, the Fed will quickly turn around, and I don't think the market has priced in that risk." Takei said he would increase his holdings of 5-10 year U.S. bonds.
Median estimates by officials show that they expect only one rate cut this year, but they have increased their expectation for rate cuts in 2025.
Powell appears to agree with the market's doubts, downplaying the importance of rate forecasts and saying that the actual path will depend on future economic data. He said the May inflation data was "welcomed" and the officials "hope to see more of this." George Goncalves, head of macro strategy at Mitsubishi UFJ Financial Group in the US, said:
"Powell appears more hawkish just to shift people's attention away from the timing of the first rate cut."
Edited by Jeffrey