How a Neutral Outcome Planned Event Can Lead to Significant Changes in Markets
Alexander Ovchinnikov
Sep 21, 2023It was expected that yesterday's US Federal Reserve meeting would go without surprises — the rate would not be raised, and the usual incantations would be spoken. The rate indeed remained at the same level, and following the meeting, Federal Reserve Chairman Jerome Powell stated readiness to act if necessary (and there are reasons to worry, such as the accelerated growth rates of oil, which is trading around $90 per barrel). At least 12 out of 19 members of the Open Market Committee supported him, stating the justification for another rate hike this year. What was expected from the Fed was also clearly articulated — high rates will stay with us for a long time (the median now shows a rate cut of 50 b.p. in 2024 compared to 100 b.p. previously).
The meeting, however, delivered a surprise. The Fed significantly changed its assessments of economic growth rates (the assessment was raised from moderate to stable) and the labor market (it was acknowledged that job growth has "slowed," but "remained strong"). In numerical terms, it looks as follows:
- the June GDP forecast for the entire 2023 year was revised upwards from 1.0 to 2.1% (the forecast for 2024 was also raised from 1.1 to 1.5%);
- June expectations regarding unemployment in 2023 were lowered to 3.8% compared to 4.1% previously.
These are significant changes in the central bank's forecasts that cannot go unnoticed. And the markets are reacting — on one hand, we see that short-term T-Bill rates remain around 5.5%: according to CME Group, the probability that the Fed rate will be maintained in November is already estimated at 71.6% compared to 68% just yesterday. On the other hand, we note that long-term rates are soaring: the yield on 10Y UST is already around 4.5% (4.22% just literally a week ago).
Why is this happening? Long-term rates are not tied to the central bank rate but are always the expectations of market participants regarding the economy and inflation, risks, and many other factors, including technical ones. Therefore, the central bank's upward revision of economic growth forecasts affects long-term rates and is a negative signal for the markets. That is, in practice, the yield curve should become less inverted, and the spread between short-term (central bank rates) and long-term rates (economy) should now become less negative.
What could hinder this?
- Risks in the US stock market or outflows from global markets due to negative trends for economies amid a strengthening dollar and rising rates could increase demand for safe assets, and the yield on long-term UST may decrease.
- Risks regarding the American economy (i.e., a decrease in positive expectations), for example, a government shutdown in the US from October due to parties not agreeing on the budget process. However, there are doubts about this point — not for nothing has the Treasury aggressively borrowed on the market in the last three months, financing the budget.
