Cut and Runoff
The Federal Reserve cut rates by 25 basis points today, bringing the new target range for the fed funds rate to 3.75-4.00%. This move was widely expected and almost 100% priced into markets before this week’s meeting. In addition to the rate cut, the Fed also announced that they would be ending their balance sheet runoff program called quantitative tightening (QT) on Dec. 1. This had become a more widely expected part of the message before the meeting, but the exact timing was uncertain. Markets had previously expected the end of QT to be Dec. 31, so this simply moved it up one month. The final big development from this meeting was that there were two dissenting votes. One dissent was from Fed Governor Stephen Miran who favored a 50-basis-point cut, and the other was from Kansas City Fed President Jeff Schmid, who favored leaving rates unchanged.A Hawk in Dove Clothing
Fed Chair Jerome Powell didn’t say, “You’re not listening,” but he may as well have. Before the press conference began, the market had priced in a greater than 90% probability of an additional 25 basis point cut in December, but Powell reiterated more than once that a cut in December is not a foregone conclusion. Importantly, he indicated that they may exercise caution on further cuts simply because there’s too much uncertainty in the data. That message made this rate cut a hawk in dove clothing. The cut and the earlier end to QT were dovish, but reducing the likelihood for a cut in December gave it a hawkish tone. During Powell’s comments, market pricing moved down to 60% odds for a December cut. Stocks did not respond positively to that perceived change in plans.Intraday Stock Moves
With equity markets near all-time highs and risk appetite strong among investors at large, markets are eager to receive dovish messaging that supports liquidity, increasing valuations, and risk-taking in general. Knowing that, this reaction was perhaps understandable.
Freeze
Leading up to the Fed meeting, investors had increasingly expected to hear some indication of when QT would be ending, so this wasn’t much of a surprise. But it could have, or even should have been interpreted as another dovish signal, since the end of QT means that the Fed will stop reducing its balance sheet, which is positive for liquidity and funding markets. The main reason they’re ending QT is illustrated in the chart below. Bank reserves are still in ample territory, but at risk of falling into scarce territory. In order to maintain healthy bank reserves, QT needs to end soon, which effectively freezes the size of the Fed balance sheet.Quantitative Tightening Ends December 1
I view this as a positive development, although I honestly expected them to announce an even earlier end date. In any event, this is a step that can help prevent funding stress and liquidity issues, and should be broadly supportive of stock prices.
Treasurys Talk Back
The final highlight from today is the move in Treasury yields. The Fed has now cut rates by 50 basis points over the last two meetings and announced the end to QT. Again, these are undoubtedly dovish moves, despite some hawkish tone surrounding the actions. Yet Treasury yields rose during the press conference.Intraday Treasury Yields
Moreover, the 10-year yield is roughly flat since the last rate cut, and the 2-year yield is above where it was then. In other words, the yield curve has flattened. This muddies the waters considerably, and I don’t think it’s getting enough attention.
The fact that the curve has flattened could mean a few things: 1) There is some concern over future growth prospects that keeps investors buying the 10-year Treasury, 2) The Treasury market has been really good at predicting what the Fed will do, 3) Uncertainty due to a lack of economic data is making investors increasingly nervous.
It’s possible that all three of these are true. Regardless, the Treasury market seems a bit confused about whether things are improving or deteriorating, yet the stock market seems convinced that things are good and getting better. Through the end of the year, I think the stock market momentum can remain the strongest force, but we shouldn’t ignore some of the quiet warnings Treasurys might be sending.
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