Strongly Divided FOMC Decided to Implement a Back-to-Back 25 “Risk Management” bps Rate Cut

Markets

“A further reduction in the policy rate at the December meeting is not a foregone conclusion. Far from it.” A strongly divided committee (on the near term future) decided to implement a back-to-back 25 “risk management” bps rate cut yesterday, but in no way wanted to put the Fed policy on a preset course going into the final FOMC meeting of this year. A better flow of data would come in handy. Two Fed governors dissented against the 25 bps rate cut (Fed Miran in favour of 50 bps; Kansas City Fed Schmid calling for unchanged decision). At 3.75%-4%, the Fed’s policy rate for the first time entered the 3%-4% zone which the majority of Fed governors in the September dot plot indicated as neutral territory, though Fed Chair Powell personally still calls it moderately restrictive. Throughout the presser, Powell on several occasions placed himself in the camp of those who seem willing to proceed with another rate cut in December, but he stressed that Minutes of yesterday’s meeting will show the very strong division within the FOMC making the December outcome too close to call for now. In general terms, Powell explained that a neutral position is the one you’re looking for when the dual Fed’s mandate (downside risks to the labour market vs upward inflation risks) calls for opposite policy action. The labour market hasn’t been significantly deteriorating the past four weeks and Powell suggested that more signs of labour market strengthening or even stabilizing would certainly play into the central bank’s decisions going forward. More hawkish members inside the Fed already point out that the Fed’s tools can’t help the labour market when (a sharp drop in) supply (especially migration) is the bigger/only problem. It means that less jobs are necessary overall, so no need in stimulating demand. Powell noted though that job creation is very low as well, putting the labour market in its current curious stable state. Inflation away from tariffs (goods prices) is not so far from the Fed’s goal though according to Powell (2.3%-2.4% vs 2.8% Y/Y actual core PCE). The base case remains that tariff inflation will be a one-time increase. It helps that the labour market isn’t tight to avoid second-round effects while inflation expectations are currently under control as well. He also pointed out that housing services inflation has been coming down and is expected to continue to come back. Apart from the interest rate decision, the FOMC decided to stop its quantitative tightening process from December 1st. Since June 2022, assets in the bond portfolio declined by $2.2tn. In a next phase, the Fed wants to keep its total balance sheet stable. That implies that reserves will continue to shrink mechanically as other balance sheet categories grow in a natural way. Proceeds from maturing US Treasuries and MBS will be reinvested in US T-bills, shortening the duration of the asset portfolio to better match it with the duration of the outstanding universe of US T’s. At some point down the future, the Fed will return to gradually growing its reserves to keep up with the size of the banking system and the size of the economy. That would be the final process of the Fed’s normalization process.

The US yield curve started bear flattening from the start of Powell’s Q&A with US yields adding 8.5 bps (30-yr) to 10.8 bps (2-yr) as money markets trimmed bets on a December 25 bps rate cut from 100% to 70%. The dollar initially profited from the rate support with EUR/USD dipping from 1.1660 to 1.1580. The move is already partly undone this morning as the Xi-Trump meeting ended. GBP/USD tested key support at 1.13140 with GBP weakness at play as well. USD/JPY moved in two steps from 152 to 153. USD-strength was followed by JPY-weakness after the BoJ kept its policy rate unchanged at 0.5% in the same 7-2 split vote as September. The BoJ kept its GDP and CPI forecast broadly unchanged though the increase in next fiscal year’s core CPI prognosis from 1.9% to 2% is meaningful. The BoJ narrative remains the same: preparing for a next rate hike in due time. Between now and December, the BoJ receives two months’ worth of additional data. The market-implied probability of such move stands at 45%. US stock markets returned part of trade/AI-driven gains with key indices closing between 0.16% lower (Dow) and 0.55% higher (Nasdaq). Equity futures are mixed overnight as they have to digest more news. Microsoft (strong numbers, but splitting hairs on computing capacity crunch; -4%) and Meta (good numbers, but huge Q3 tax bill and concerns about overspending on AI; -7%) shares lose ground following Q3 earnings releases, while Alphabet (big beat, huge capex effectively fueling growth; +6%) makes clear advances. Finally, US President gave a debrief on his encounter with Xi Jinping. He rated the meeting a 12 out of 10 with the two agreeing to meet again in China in April. Most other headlines matched chatter in the run-up. US tariffs on China will be 47%, down from 57% because of lower fentanyl-related charges. He touted agreement on soy beans and other agricultural products, no roadblock on rare earths, discussions on chips and the postponement of US shipbuilding probes. An official statement will be released later. Today’s main question is whether the hawkish Fed rate cut, mixed earnings reaction to big tech and expectations-matching Trump-Xi Summit are sufficient to keep the risk rally going.