Financial markets are settling into a narrative in which the Federal Reserve is likely done with raising interest rates, while reversing some of the tight conditions that had been helping to do the central bank’s job.
Long-term Treasury yields finished lower for a third day in a row on Thursday, with 10-
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and 30-year rates
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moving further away from 5% on renewed buying interest in government debt. Rising yields had been among the factors cited by Fed Chairman Jerome Powell on Wednesday for a significant tightening in financial conditions over recent months, which are likely to weigh on the economy.
The question now is whether the market’s view that the Fed is done might be too early to call. Chief Executive Jamie Dimon of JPMorgan Chase & Co.
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said he suspects the central bank may not be finished and pointed to the possibility of an additional 25 to 75 basis points of rate hikes which could be needed. Meanwhile, Bill Dudley, ex-president of the New York Fed, told Bloomberg he sees one of two scenarios unfolding: “Zero or multiple rate hikes.”
Read: Jamie Dimon says businesses should be prepared for interest rates to go higher in case it happens
“If it turns out inflation comes roaring back, one rate hike is not going to do it” now that the Fed has stopped, said Chris Zaccarelli, chief investment officer for Independent Advisor Alliance in Charlotte, N.C., which manages more than $10 billion in assets. “We’re going to need three or more. We think the only way inflation is going to get back to 2% is through economic pain — a steep slowdown, or a recession, or unemployment that goes much higher.”
Considering the U.S. economy grew at a blistering 4.9% pace in the third quarter and nonfarm payrolls grew by a whopping 336,000 new jobs for September, the Fed has had “every reason” to raise rates but hasn’t, Zaccarelli said via phone on Thursday. “That’s where the stock market is getting the conviction that the Fed doesn’t want to raise rates anymore. It may take some time before the Fed is proven correct or incorrect, and that’s why this rally can have some legs” through year-end.
Read: Why stock-market bulls say ‘Santa rally’ may have already started as equities surge to kick off November
The Dow Jones Industrial Average
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closed up by more than 500 points on Thursday, with all major stock indexes
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adding to this week’s gains. Meanwhile, the ICE U.S. Dollar Index
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which reflects where traders expect U.S. interest rates to be headed relative to the rest of the world, fell 0.7%. And 10- and 30-year Treasury yields respectively dropped by 12.2 basis points and 15.4 basis points to 4.668% and 4.820% — the lowest levels since Oct. 13, according to 3 p.m. Eastern time figures from Dow Jones Market Data.
Thursday’s bullish momentum in both stocks and bonds was accompanied by an 80.2% likelihood from fed funds futures traders that the Fed will leave rates unchanged through December. On Wednesday, central bankers opted to pause rate hikes for a second straight meeting, leaving their main interest-rate target at a 22-year high of 5.25%-5.5%.
“What a difference 24 hours makes!” Gennadiy Goldberg, head of U.S. rates strategy for TD Securities in New York, wrote in an email Thursday morning. “The rally continues today as the market is jumping on the bandwagon and bullish momentum is seemingly taking hold.” He said that “we expect data to begin softening in the coming months and continue to look for a second quarter 2024 recession, which will put downward pressure on rates.”
In a nutshell, investors and traders are focusing on the likelihood that the U.S. inflation problem will be vanquished by slowing economic momentum and a Fed that’s already hiked rates by more than five full percentage points since March 2022.
On Wednesday, Powell said that policy makers are focused on whether rates are restrictive enough to bring inflation down to 2% over time, and the question they are asking themselves is, “Should we hike more?”
Meanwhile, a pause by the Fed carries risks, according to Dudley, president of the Federal Reserve Bank of New York between 2009-2018. In a Bloomberg column, Dudley wrote that policy makers risk unleashing a repeat of the 1970s-1980s by keeping rates on hold. And after the Fed’s policy announcement on Wednesday, he said that if officials end up needing to do more, a single quarter-point rate hike won’t likely be enough.
At Deutsche Bank, economists Amy Yang, Matthew Luzzetti, and others said in a note that “underlying inflation shows signs of stabilizing in the 3%-3.25% range” — raising the risk that the Fed will need to tighten policy further, particularly if financial conditions ease.
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