Nov 14, 2019

The market got the rate cuts it wanted

Data: CME FedWatch Tool; Note: Data as of Nov. 13 at 5:44pm CT; Chart: Andrew Witherspoon/Axios

Fed chair Jerome Powell again laid out his rose-colored view of the U.S. economy on Wednesday, telling the congressional Joint Economic Committee that he sees the U.S. as “being in a good place." He reiterated that a "material reassessment" of the economic outlook would be required for the Fed to raise or cut interest rates any time soon.

Why it matters: Powell's testimony was the cherry on top of the good news sundae that has sent traders' appetite for risk soaring over the last two weeks, and priced out expectations for further U.S. interest rate cuts through the end of next year.

What we're hearing: "It's amazing the collective wisdom of the market," says Gautam Khanna, senior portfolio manager at BNY Mellon, which manages at least $1.3 trillion in assets.

  • When the Fed raised rates in December, "the market said the Fed was making a mistake. 'Europe is slowing, we're facing a trade war, there's Brexit,' and it reacted. The Fed has since [cut interest rates three times] and the market is happy with that," Khanna tells Axios.

Powell has maintained this rosy outlook all along, "but the market needed to see the rate cuts," Lale Akoner, BNY Mellon's global market strategist, adds.

  • "Now that the market has received those rate cuts, financial conditions have eased, which will avoid a hard crash" for the economy.

Watch this space: Akoner says she expects the Fed to remain on pause through the end of next year and for U.S. Treasury yields to rise by around 100 basis points in the near future.

Between the lines: Fed fund futures pricing has shown investors consistently betting the economy would deteriorate this year and into 2020, forcing the Fed to continue to cut rates at least two more times by June.

  • Over the past month the market has reversed those bets, and now is pricing in a less than 5% chance of a cut before year-end and less than a 50% chance of a rate cut by December 2020.

Quick take: “Looking ahead, my colleagues and I see a sustained expansion of economic activity, a strong labor market, and inflation near our symmetric 2% objective as most likely,” Powell told the congressional committee Wednesday.

  • "This favorable baseline partly reflects the policy adjustments that we have made to provide support for the economy.”

What's next: Investors will be closely watching U.S. economic data to see if that is the case.

Go deeper: Recession fears have vanished

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