Is Powell signalling end of Fed's tightening cycle?

Was Post Fed Chair Speech Rally a Market Overreaction

Federal Reserve Chairman Jerome Powell ignited a market rally Wednesday by saying interest rates are "just below" broad estimates of a level considered neutral, a setting created to neither speed nor slow economic growth. Investors interpreted as Powell either changing his position on interest rates or attempting to correct the incorrect interpretation of his earlier remarks.

Powell "gave the market, and presumably President Trump, exactly what he wanted, which was an admission that the previously proposed path of future rate hikes was probably too aggressive and opening to slowing the rate of hikes", said Oliver Pursche, vice chairman and chief market strategist at Bruderman Asset Management in NY.

The current Federal Fund rate is 2.25 per cent, and there is a 77 per cent probability of a 25-basis point increase in the December meeting scheduled in the week before Christmas.

"Recent public comments suggest Fed officials are amenable to parking the fed funds rate near neutral, which most FOMC participants estimate near 2.9 percent to 3 percent, and then pausing to assess the health of the economy as it adapts to less accommodative policy".

While the Fed is expected to raise rates by a quarter point at its meeting on Dec 19, it has forecast to have three more hikes next year.

Minutes of the USA central bank's November 7-8 meeting showed "almost all participants" agreed that another rate hike would likely be necessary "fairly soon". Rather, we assume that Powell wanted to prepare the markets for a change in the central bank's communication.

Powell in his remarks Wednesday also raised the importance of policymakers staying flexible in charting a path of policy given that the effects of rate hikes show up with a lag - a point that was reinforced in the Fed's November minutes. This is probably because Fed Chair Jerome Powell stole most of the thunder the day before with his dovish remarks about the fate of future rate hikes.

"If you look down the road, you see challenges ahead, and they're challenges that are typical in a cycle", said Powell speaking earlier this month at the Federal Reserve Bank of Dallas.

On Wednesday, Powell also emphasised these uncertainties.

Powell, in remarks just two weeks ago, had listed three possible challenges to growth in 2019: slowing demand overseas, fading fiscal stimulus at home and the lagged economic impact of the Fed's past rate increases. "I think that's what we've been doing".

"We also know that moving too slowly - keeping interest rates too low for too long - could risk other distortions in the form of higher inflation or destabilizing financial imbalances".

The dollar, which has outperformed bonds and the S&P 500 this year, benefiting from rising interest rates and safe-haven flows triggered by global trade tensions, fell back after Powell spoke. But that approach is no longer appropriate, Powell said. Three of those increases have been under Powell.

With last year's deep tax cuts and fiscal stimulus from Congress, the world's largest economy continues to hum: producing steady job growth and driving the unemployment rate to its lowest level since 1969 even as inflation remains right at the Fed's two percent target.

With a December increase broadly expected, that meeting may stand out more for the fresh economic projections that policymakers will issue, providing a clearer view of how their perceptions of the economy and the proper path for rates may have changed in recent weeks.

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