As Hawkish A Cut As Powell Could Muster

WHERE WE STAND – The FOMC delivered about as hawkish a cut as they could muster up yesterday, and market participants were not particularly pleased about what they heard.

As expected, Powell & Co delivered a 25bp cut to the fed funds rate, lowering the target range to 4.25% to 4.50%, bringing the cumulative amount of easing this year to 100bp, as the Committee continue to return rates to a more neutral level, and ensure a ‘soft landing’ for the US economy.

However, the guidance and projections accompanying said rate cut were undeniably hawkish. The updated ‘dot plot’ showed a median expectation of just 50bp of further rate cuts next year, half the magnitude foreseen in the September forecast, while also nudging the longer-run rate estimate higher to 3.00%, suggesting a shallower easing cycle than previously expected.

Meanwhile, Powell struck a hawkish note at the post-meeting press conference, flagging that while policy is well-positioned, the FOMC can dial back restriction more slowly if disinflationary progress stalls, or more quickly if the labour market weakens unexpectedly. In simple terms, as risks to the dual mandate become more two-sided in nature, risks to the policy outlook must also become two-sided, thus opening the door to the FOMC skipping a cut at the January meeting.

It was, though, a little perplexing to see such a violent market reaction to Powell’s remarks, particularly considering how ‘every man and his dog’ had been expecting this sort of a pivot in the run up to the meeting.

Treasuries sold-off across the curve, with 2-year yields rising over 10bp on the day, while the benchmark 10-year yield surged north of 4.50%. In turn, this pressured risk appetite, as equities slumped across the board, with the S&P notching a 3% decline, its worst ‘Fed Day’ performance since March 2020, while the Nasdaq 100 fell almost 4%.

The dollar also vaulted higher against peers, as the DXY reclaimed the 108 handle, rallying over 1%, while the BBDXY rose to its best level since November 2022. In turn, other G10s lost ground, with the EUR sliding to within inches of fresh YTD lows around 1.0350, cable surrendering the 1.27 and 1.26 handles, while the AUD & NZD both lost well over 1.5%.

It feels, though, as if markets have over-reacted to Powell’s message, and that we may have reached something of a hawkish extreme here, particularly with the USD OIS curve now pricing just 31bp of easing over the entirety of 2025. Consequently, I’d be a dip buyer of equities here, as strong earnings and economic growth should see the path of least resistance continuing to lead to the upside, offsetting the fading impact of the ‘Fed Put’. I’d also be a seller of vol, particularly with the VIX running as high as 28 during yesterday’s session.

The FX space is a little more complex, though I remain a dollar bull, and a firm believer in the case for ‘US exceptionalism’ to continue, some longs may use this rally to take profits off the table before year-end, particularly before potentially USD-negative year-end flows begin to turn the FX market into a choppy and noisy mess.

LOOK AHEAD – Another busy day of policy decisions lies ahead.

Kicking things off this morning, the Riksbank are set to deliver a further 25bp cut, taking rates to 2.50%, as policymakers continue to keep pace with the ECB. Guidance is likely to not towards further such cuts in Q1 25, though 2% is likely to prove to be this cycle’s terminal rate, as upside inflation risks increasingly emerge. Across the border, the Norges Bank are set to hold rates steady at a cycle high 4.50%, with focus therefore falling on the NB’s policy guidance, and the likely pace of easing to be delivered next year, with the NOK OIS curve discounting a full 25bp cut by next March.

Closer to home, the Bank of England announce policy this lunchtime, with the MPC set to have voted 8-1 in favour of maintaining Bank Rate at 4.75%. External member Dhingra is, again, likely to favour an immediate 25bp cut, cementing her place as the MPC’s resident uber-dove. The Committee’s guidance, meanwhile, is likely to stress that a gradual pace of removing policy restriction remains appropriate, as policymakers remain data-dependent, and focused on signs of inflation persistence. This week’s above-forecast earnings data, and hot CPI figures, reinforce the MPC’s cautious approach, with the next 25bp Bank Rate cut likely to be delivered in February.

Besides policy decisions, there are a handful of notable data releases due. The final read on Q3 US GDP is unlikely to be revised, pointing to growth of 2.8% on an annualised QoQ basis over that period. The US also release the weekly jobless claims figures, with the initial claims print pertaining to the December NFP survey week, ass well as the monthly Philly Fed manufacturing survey, and the latest existing home sales report.