(Bloomberg) — Jerome Powell’s Federal Reserve did something Wednesday it hadn’t done for months: say something dovish. Investors had all of 30 minutes to celebrate.
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Like a reproving parent, the Federal Reserve chairman quickly put the kibosh on any budding euphoria his comments about monitoring the lagged effect of interest rate policy might have provoked. Rates are still going up, he reiterated, probably more than people thought.
The result was a painful bait-and-switch for stock and bond bulls. After surging 1% in the half-hour after the Fed decision was released, the S&P 500 Index sank when Powell said it was “very premature” to think about the central bank’s historically aggressive tightening cycle taking a pause.
The benchmark finished down 2.5% for its worst Fed day performance since January 2021. It was also the first time since 2008 that the S&P dropped more than 1% on two consecutive Fed days, Bloomberg data show.
Yields on two-year Treasuries — the tenor most-sensitive to the expected path of Fed policy — initially dropped after the statement’s release, only to sharply reverse course and climb nearly 6 basis points as investors priced in a higher terminal rate.
The velocity of the S&P 500’s decline, also its worst single-day drop since mid-October, reflects both Powell’s intransigence on rates as well as the unwinding of bets that a more forthright policy pivot was in the offing. The stock index had climbed 8% in the weeks before Wednesday’s meeting, another instance of dashed hopes the Fed would throw investors a more lasting reprieve.
“We got 30 minutes before the press conference started — and then cold water on the doves from Powell,” said Victoria Greene, founding partner and chief investment officer at G Squared Private Wealth. “It’s a big disconnect in messaging between the large release update and the press conference tone and responses. Confusion has set in on the market versus a solid message.”
The market was keyed into every word Powell uttered. After an initial jump, equities reversed when the chairman said the ultimate level of interest rates would be higher than expected. They rose again when he said the shift to a slower pace of hikes could come as soon as the December meeting. But full-blown implosion ensued when he said it was premature to think about pausing the central bank’s rate hike cycle.
While whipping up volatility, policy makers succeeded in one goal: putting the possibility of a less-strident Fed on the table without inciting any undue market jubilation. Preventing a full-blown celebration from breaking out matters a lot to Powell given the role of rising stocks in loosening the economic conditions he’s trying to restrict.
“The equity market is part of a set of variables that tell them where financial conditions are and so it would be inconsistent with what the Fed is trying to do for equity markets to rally substantially,” Michael Gapen, head of US economics at Bank of America Corp., said on Bloomberg TV. “That is not necessarily what the Fed is trying to achieve.”
The final blow for bulls seemed to be Powell’s admission that the ultimate ceiling on the Fed’s hiking campaign may be higher than expected. Traders were quick to react: while pricing for the so-called terminal rate dropped below 5% in the aftermath of the statement, it climbed to 5.1% while Powell spoke.
The end game of the Fed’s rate hikes matters more for risk assets than the magnitude of rate increases, according to Bianco Research LLC.
“We’re going to focus on, where is the destination?” said Jim Bianco, president of Bianco Research LLC, said in an interview. “The risk markets desperately, desperately want them to stop and what they basically said is they’re not going to stop.”
–With assistance from Lu Wang.
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