Tuesday, December 11, 2018


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Jerome Powell, Chairman of the Federal Reserve, speaking at the New York Economic Club on Nov. 28th, 2018. 

Adam Jeffery | CNBC
Jerome Powell, Chairman of the Federal Reserve, speaking at the New York Economic Club on Nov. 28th, 2018. 

Stocks surged and bonds sold off Wednesday afternoon in a powerful move, after market pros took Fed Chairman Jerome Powell’s comment to mean the Fed is nearing an end of its rate-hiking cycle.

Powell said the Fed’s key benchmark interest rate is near the neutral rate — the rate where the Fed could consider stopping rate hikes. That’s an important change from a comment he made in early October about the neutral rate being a long way off.

The Dow surged by more than 500 points, and the 2-year Treasury yield, most reflective of the Fed rate policy, sold off hard. The 2-year yield fell to 2.79 percent after reaching a high earlier of 2.85 percent.

“It’s a game of semantics because after a rate hike in two weeks, the fed funds range is going to be 2.25-2.50 percent, and if 3 percent is neutral, then 2.5 is just below 3,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “The market is taking this as maybe we’ve got two hikes left, and we’re close. It’s a word game, but I think that’s what people are latching onto.”

After Powell’s comments, BMO U.S. rates strategist Jon Hill said, the futures market went from pricing in 1.6 hikes next year, to just above one full rate hike and a 25 percent probability of a second one. It’s still pricing in a full December rate hike.

The Fed is expected to raise rates by a quarter point at its meeting Dec. 19, and has forecast three more hikes for next year.

“If there’s only one hike priced in for all of 2019 and they hike in December, then things have to get really great for them to hike more than once because the market is now almost guiding them in a way,” said George Goncalves, head of fixed income strategy at Nomura.

Goncalves said there’s a level of skepticism in the bond market’s reaction. For instance, while the 2-year yield fell, the 30-year bond yield rose, and it was at 3.33 percent. Bond prices move opposite yield.

“There’s some concern that what if the Fed makes a policy mistake and stops too soon,” said Goncalves. He said the move may also be an unwind of a trade that flattened the yield curve, or where traders bought long end securities, like the 10- and 30-year, and sold the short end or 2-year because of Fed rate hikes. That so-called ‘flattener’ was viewed as a signal of possible economic trouble on the horizon that could eventually lead to an inverted curve, and a recession.

“You have these entrenched trades based purely on Fed hiking, and now that’s being questioned. How far are they going to go? And the month end is in a few days so you could have positioning money coming out of bonds and going into equities,” he said.

Ward McCarthy, chief financial economist at Jefferies, said Powell was confirming the Fed’s forecast. “They are shooting for 3 percent,” he said. Neutral is the rate at which the Fed believes its benchmark interest rate neither stimulates nor slows the economy, but what that level is has been the topic of much debate.

Some economists, including those at Goldman Sachs and J.P. Morgan Chase, have four interest rates hikes in their forecasts for next year. Those forecasts had added to concerns in the market that the Fed would move ahead with more rate hikes than markets expected.

Traders said Powell’s comments about the neutral rate on Oct. 3 had shaped the market’s thinking that the
Fed was hawkish —in that it saw a strong U.S. economy and therefore would hike aggressively. But Fed officials, in recent comments, began to sound more dovish, pointing to concerns about financial conditions overseas

Traders had been hoping for a dovish sounding Fed chairman but Powell was even more dovish than expected.

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