After the Federal Reserve’s (Fed) decision to hold interest rates steady in October, market expectations for an additional rate hike in December fell from 90.7% to 84.8%. While the pause itself was in line with predictions, analysts noted that Fed Chair Kevin Warsh’s lack of clear commitment to further tightening raised questions about the central bank’s resolve to combat inflation.
A report released on Thursday by the Bank of Korea’s New York office, titled, Market Participants’ Assessment of the October FOMC Meeting Results and Financial Market Reactions, indicated that market participants viewed the meeting outcomes as less hawkish than anticipated.
During the Federal Open Market Committee (FOMC) meeting held from Tuesday to Wednesday, the Fed maintained the federal funds rate at 3.75% to 4.00%. Ten committee members supported the decision, while Fed Governor Lisa Cook and Cleveland Fed President Beth Hammack advocated for a 0.25 percentage point increase.
December Rate Hike Probability Falls 5.9 Percentage Points… Short-Term Yields Drop While Long-Term Yields Rise
The probability of a 0.25 percentage point additional hike in December, as reflected in federal funds rate futures, fell by 5.9 percentage points from 90.7% to 84.8%. Expectations for cumulative additional hikes until the first half of next year also decreased from 2.8 to 2.6 times based on a 0.25 percentage point increase.
In the bond market, short-term yields decreased while long-term yields increased, widening the spread. The U.S. dollar weakened, and stock prices climbed, buoyed by strength in the semiconductor sector.
The Bank of Korea explained that markets primarily reacted to a perceived weakening of confidence in Fed policies. As in the July meeting, doubts about the Fed’s commitment to price stability resurfaced, pushing long-term Treasury yields higher.
Market participants had expected that even if the Fed held rates steady, Chair Warsh would emphasize the commitment to price stability and the possibility of further tightening. However, during the press conference, he did not clearly express a willingness for additional hikes, and analysts felt that explanations for the pause and specific measures to curb inflation were inadequate.
The policy statement did include some hawkish signals. The Fed upgraded its assessment of economic conditions, changing the phrase expanding at a moderate pace to expanding at a strong pace.
However, regarding the return to the inflation target, the Fed altered the phrase more rapid return to timely return and added language suggesting that accumulating additional information would help determine an appropriate monetary policy stance.
Chair Warsh indicated that while the effects of monetary policy actions since September are beginning to show, it’s too early to draw definitive conclusions, and he plans to monitor incoming data.
Rationale for Holding Rates Unclear … Inflation Control in Doubt Despite Smaller Rate-Setting Meetings
Bank of America viewed the upward revision of economic growth as a hawkish adjustment supporting the case for maintaining high interest rates. However, they noted that the press conference lacked clear additional information or policy guidance, further fueling doubts about the Fed’s commitment to price stability.
Morgan Stanley maintained that the economic assessment in the statement still leans toward the possibility of additional rate hikes. However, they expressed skepticism about Powell’s ability to convince financial markets, given the lack of clarity on the rationale for the pause, interpreting this decision as a delay tactic to review additional data and task force research results.
The restructuring of the FOMC meeting format also contributed to market skepticism.
The Fed will maintain its eight meetings per year but plans to convert one meeting in 2027 and two in 2028 into discussions on monetary policy strategy without rate votes or policy statements. As a result, the number of meetings that actually determine rates will decrease to seven and six, respectively.
JPMorgan assessed that the announcement of meeting structure changes, coupled with tepid comments on inflation, raised doubts about the Fed’s commitment to price stability. Following the press conference, the yield spread between 2-year and 30-year U.S. Treasury bonds widened, reflecting weakened policy credibility, particularly in the long-term bond market.
Goldman Sachs Group, Inc. noted Chair Warsh’s acknowledgment of a close relationship between artificial intelligence (AI) investment and interest rates. They suggested that to avoid stifling AI investment, the Fed might slow the pace of future rate hikes.
However, some analysts argued that the possibility of an additional hike in December is not completely off the table.
The Wall Street Journal reported that neither the monetary policy statement nor Chair Warsh’s press conference provided sufficient evidence to overturn market expectations for an additional rate hike in December.
