The US stock markets experienced a tumultuous week, with Jerome Powell’s speech leading to a wild ride for Wall Street. Powell, the head of the Federal Reserve (the Fed), surprised analysts by hinting at a potential shift in monetary policy, which sent bond and stock prices soaring. This came as a shock to many, considering the current economic climate.
The Fed’s announcement of potential interest rate reductions caused concern among central bank officials, as it posed a threat to their goal of slowing down the fight against inflation. Despite attempts by New York Fed President John Williams to calm the market’s enthusiasm by stating that it was premature to talk about a March interest rate decrease, the markets continued to rally.
“I’m perplexed” by Powell’s remarks after the Fed meeting, said Sonal Desai, Franklin Templeton’s chief investment officer of fixed income. Desai questioned the need to accelerate the fall in rates, especially when the market had already been playing a role in setting stricter financial conditions as rates increased. He suggested that the Fed should attempt to calm down the market in the coming weeks if it truly wanted to be cautious.
The impact of Powell’s speech was evident in the Goldman Sachs financial conditions index, which plummeted this week. The index takes into account factors such as stock prices, credit spreads, interest rates, and currency rates. The decline since the end of October, when Treasury bond yields surged, now exceeds 1%. This steep decline reflects the market’s reaction to the Fed’s increased anticipation of rate cuts in the coming years.
Market participants and financial institutions adjusted their plans following the Fed’s announcement, preparing for steeper rate cutbacks in 2024. Swap contracts linked to Fed meetings indicate an 80% chance of rate reduction beginning in March 2024, with an estimated total of around 150 basis points. Williams, an influential figure in conveying central bank policy, had previously advised against considering a taper in March, but his remarks did little to reverse the market’s response.
The two-year US Treasury note, which is directly linked to the Fed’s monetary policy outlook, experienced volatility during the week. The yield initially rose following Williams’ remark but quickly fell back down. Throughout the day, the yield stabilized at 4.41% annually, and it is expected to end the week down by approximately 30 basis points.
Chris Iggo, investment director from AXA Investment Managers, noted before Williams’ comments that the end of rate increases and the next phase of the cycle characterized by monetary easing were already in place. Iggo predicted resistance in terms of rate cut timelines from Fed members but believed that the market dynamics would be hard to change.
Overall, Powell’s speech created a wild ride for Wall Street, leaving many perplexed by the potential acceleration of rate cuts. The market’s response, reflected in the decline of the Goldman Sachs financial conditions index and the fluctuation of the two-year US Treasury note yield, demonstrates the impact of the Fed’s announcements. As the markets continue to react, it remains to be seen how the Fed will navigate this new landscape and whether they will attempt to calm down the market in the coming weeks.