Dismissal of Rate Hike Possibility... More Dovish Than Expected
Powell "Inflation Progress Insufficient... Rate Cuts Will Take Long"
Fed Holds Benchmark Rate Steady for 6th Time... Eases Quantitative Tightening Pace from June
"It will take longer than previously expected to gain confidence in a rate cut. However, the current interest rate is sufficiently restrictive, and the next move is unlikely to be a hike."
Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), drew a line on the possibility of a rate hike while expressing concerns about strong inflation. As the Fed held the federal funds rate steady for the sixth consecutive time at this year's third Federal Open Market Committee (FOMC) meeting, the market, which had worried about Powell's hawkish (monetary tightening preference) remarks due to recent inflation strength, is now reacting positively to the more dovish (monetary easing preference) message than initially expected. The three major New York stock indexes expanded their intraday gains or turned upward on the day.
At a press conference held immediately after the May FOMC regular meeting on the 1st (local time), Chairman Powell said, "The likelihood that the next policy rate move will be a hike is low," adding, "I want to say it is almost impossible."
When asked whether a rate hike was discussed, he replied, "There was policy discussion about maintaining the current restrictive level." He explained that there was no discussion about a rate hike.
He viewed inflation itself as stronger than expected. Powell said, "Inflation is still too high, and we cannot guarantee progress toward a decline," adding, "We expect inflation to fall this year, but the data have weakened that confidence." He further stated, "It will take longer than previously expected to gain confidence in a rate cut."
The Fed kept the federal funds rate unchanged at 5.25?5.5% at this FOMC meeting. This marks the sixth consecutive hold following decisions in September, November, and December of last year, and January and March of this year. As a result, the interest rate gap with South Korea was maintained at 2 percentage points at the upper bound.
In the policy statement released that day, the Fed newly added language indicating no progress in slowing inflation. The Fed assessed, "In recent months, there has been a lack of additional progress toward slowing inflation to the 2% target." It also stated, "When considering adjustments to the target range for the federal funds rate, we will carefully assess incoming data, evolving outlooks, and the balance of risks," and "It is not appropriate to reduce the target range until we have greater confidence that inflation is moving sustainably toward 2%."
Additionally, the Fed hinted at plans to slow the pace of quantitative tightening, known as balance sheet reduction. Starting in June, the Fed plans to reduce the monthly Treasury redemption cap from $60 billion to $25 billion to slow the pace of securities reduction. The monthly cap on agency debt and mortgage-backed securities (MBS) redemptions will remain at $35 billion, and amounts exceeding the cap will be reinvested in Treasuries. Previously, since June 2022, the Fed has been reducing its asset size by not reinvesting $60 billion in Treasuries and $35 billion in MBS monthly.
The market is evaluating Powell's remarks as dovish. With U.S. inflation rates continuously exceeding expectations this year, the market had anticipated hawkish comments from Powell. Until early March, Powell had said the timing of rate cuts was not far off, but about a month later, in mid-April, he suddenly changed his stance, saying, "It may take longer than expected to gain confidence in inflation slowing." Accordingly, some had even expected Powell to mention the possibility of putting a rate hike card on the table during this meeting.
Renaissance Macro's Rayli Investment economist explained, "Powell believes policy is restrictive," adding, "If policy is restrictive, it means they are more concerned about the risk of growth slowing than the risk of inflation rising."
The New York stock market rose as Powell dismissed the possibility of a rate hike. The Dow Jones Industrial Average, composed of blue-chip stocks, was up 0.93% as of 3:33 p.m., expanding its gains. The S&P 500 and Nasdaq indexes reversed to gains after the FOMC, rising 0.64% and 0.99%, respectively.
U.S. Treasury yields also fell sharply. The 2-year Treasury yield, sensitive to monetary policy, had exceeded 5% in the morning but is currently down 9 basis points (1 bp = 0.01 percentage point) from the previous trading day to 4.95%. The 10-year Treasury yield, a global bond yield benchmark, is down 6 basis points to around 4.62%.
However, there is also caution that the Fed and the market should not underestimate the risk of inflation rebounding. Michael Contopoulos, Chief Bond Strategist at Richard Bernstein Advisors, said, "Powell said policy is restrictive, but there is no evidence for that," adding, "Inflation continues to show an upward trend." He further pointed out, "It is ridiculous for investors to hang on to every word Powell says."
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