Fed keeps policy unchanged

The Federal Reserve left policy unchanged at its FOMC meeting ending November 1, holding the Fed Funds rate at 5.5% on the upper bound. In its statement accompanying the decision, the Fed described the US economy as expanding at a “strong pace” and gently nudged its assessment of labour market activity higher, saying “job gains have moderated” rather than “slowed” as it was described in the September FOMC statement.

The only other notable change was to include “tighter financial” conditions, rather than tighter credit conditions alone. That may represent a reference to the rise in US Treasury yields in recent months as markets have adjusted to the Fed keeping policy at current elevated levels for longer. Since the Fed last hiked at the end of July, yields on 10yr USTs have risen more than 80bps as the market prices in a prolonged period of high rates. In contrast the 2yr UST yield has held much more stable over the same period. In his commentary after the FOMC, Fed chair Jerome Powell seemed to water down expectation of any imminent future hike, saying that “slowing down is giving us…a better sense of how much we need to do, if we need to do more.” That helped to price out the chances of a further rate hike by the end of 2023 to less than 20% from almost 30% ahead of the November FOMC.

The tone from the November meeting affirmed to us that the Fed is done hiking and the focus will now shift to when the Fed will begin to cut rates, even though chair Powell said “question of rate cuts just doesn’t come up.” Our baseline remains that the Fed will begin a sequence of 25bps quarterly rate cuts from mid-2024 with the aim of moving policy closer to a neutral stance, rather than shifting to an accommodative policy position.

Market reaction to the November FOMC was highly positive with Treasury markets rallying further after the US Treasury posted a smaller schedule of long-term debt sales at its quarterly refunding statement than markets had been expecting. Yields on the 2yr UST dropped about 14bps to move to their lowest level since early September while the 10yr UST yield fell almost 20bps. Based on our expectation that the Fed holds policy unchanged for now and will likely signal a turn lower in rates mid-way through 2024, that will give further room for UST yields to run lower in the coming months. That will also feed through to a slightly softer US dollar against peer currencies though we would emphasise the “slightly.”