Volatility has gripped financial markets since mid-October, when Fed Chairman Jerome Powell made remarks that Wall Street took as hawkish for the pace of future rate hikes.
“Interest rates are still accommodative, but we’re gradually moving to a place where they will be neutral,” Powell said during an interview with PBS. “We may go past neutral, but we’re a long way from neutral at this point, probably.”
The FOMC at its September meeting actually voted to remove the word “accommodative” from its description of the current policy path. Powell and others have said the word is no longer useful in describing how the Fed is proceeding.
Since December 2015, the central bank has approved eight quarter-point rate hikes, bringing the benchmark rate to around a 10-year high.
Powell’s statements were followed by a prolonged stock market sell-off and a rise in short-term rates. The 2-year Treasury note eclipsed a decade high Thursday and the benchmark 10-year note is around 3.22 percent, near its high point since 2011.
With November’s expected pause in rate hikes behind it, the market now will turn its sights toward December. Traders in the fed funds futures market are implying about a 93 percent probability for a hike at the year’s final meeting.
The market and the Fed differ on the path in 2019.
Fed officials at the September meeting pointed to three increases next year, but the market currently is pricing in only two. The September projections indicated at least one more hike in 2020, which the market also does not see.
The gap is significant as this week’s FOMC meeting marked the last time that Powell will not have a news conference afterward. The Fed has not hiked rates during the current cycle at a meeting when the chair did not take questions afterward. Starting in January, Powell will hold a conference after each of the committee’s eight meetings each year. That makes each gathering “live” in terms of its potential for a rate move — either up or down.
“A December rate hike appears to be a likely event at this point, but the outlook ahead is very different as the market and the Fed have differing views on how many rate hikes are in the cards for next year,” said Charlie Ripley, senior investment strategist at Allianz Investment Management.
Along with the move Thursday to keep the benchmark rate anchored at its current level, the committee voted to maintain the rate the Fed pays on excess bank reserves at 2.2 percent.
Market participants have been watching the IOER rate, as it is used as a guide for the funds rate. The two rates are now exactly equal, and if there is an appearance that reserves are getting scarce in the banking system and driving up rates, that could cause the Fed to halt the run-off of its balance sheet.
The central bank is allowing a capped level of $50 billion in proceeds to run off each month from the portfolio of bonds it purchased during its efforts to stimulate the economy. Some market participants expect the Fed will approve a 20 basis point increase for the IOER rate in December as a way to keep the funds rate from getting too close to the top end of its range. The current 2.2 percent funds rate is just 5 basis points away from the upper bound of the range.