News & analysis

The FOMC unanimously voted to keep the policy rate on hold at 5.25-5.5%, in what became a widely expected decision after prominent Fed officials stated the interplay between higher bond yields and the necessity to tighten policy rates further back in early October.

There were exactly six changes to the policy statement by our count. This was somewhat symbolic of what was set to take place in the press conference; vying for time to assess the impact of previous policy actions, Chair Powell played his cards relatively close to his chest. Whilst the rate statement recognised Q3 economic activity was strong rather than solid, and job gains had moderated instead of slowed, these alterations to language were marginal at best. Perhaps the most noteworthy change came in the suggestion that both “financial and credit conditions” are likely to weigh on economic activity. This set the tone for the main line of questioning within the press conference.

With the Fed’s decision to hold rates an almost certainty, the emphasis for markets was understandably on Chair Powell’s performance and whether his assessment of the US economy would sound as dovish as it did earlier in October.

Back then, Powell’s comments dovetailed on the back of other prominent Fed policymakers, who were seemingly priming markets to the prospect of another hold in rates in December. With journalists asking questions related to the tightening in financial conditions in today’s press conference, their ability to substitute for future rate hikes, and the recent resilience in growth data, Powell was unable to lend a broader perspective than he did back at the New York Economic Club. In focusing more acutely on current conditions though, he sounded relatively hawkish on balance. This was best displayed in an answer related to whether the Fed still holds a hawkish predisposition as per their September forecasts. Knowing that downplaying prior projections would be seen as dovish by markets, Powell instead noted that the question FOMC members themselves were asking is “should we hike more?”.

When discussing the substitution effect between higher yields and a Q4 hike, Powell stated that the duration in which effective financial conditions remained tight would determine the substitution effect. While the six weeks between now and the December 13th meeting can be considered a decent length of time, the framing of the argument in this way suggests that FOMC members are cognisant that by reneging on their September forecasts by not hiking, they could inadvertently loosen these same financial conditions heading into 2024. On the other hand, by giving forward guidance that there is a strong substitution effect currently underway, this would loosen financial conditions, thus increasing the need to hike. For this reason, the Fed’s characterisation of these dynamics is a balancing act, with the outcome unlikely to become clear this far in advance.

Nevertheless, given the characterisation that financial conditions need to remain tight for a sustained period of time, we think the onus is on the data to disprove the need for a Q4 rate hike as opposed to the other way around. This runs contrary to the view taken by swap markets, where only a 20% probability of a December hike is priced.

In terms of growth, Powell highlighted that staff didn’t put a recession back into their forecast, negating any speculation that Fed members were expecting softer growth after the rate statement now characterises strong growth in the past as opposed to active tense. Based on this alone, it seems as if the Fed remains on a hawkish hold.

For financial markets, tonight’s Fed decision has done little to alter prevailing conditions. Price action in the bond market continues to be driven by the Treasury’s decision to slow the increase in longer-term debt issuance and a reversal of September’s stronger ISM manufacturing data, while equities are also finding some relief from the lower yields. In the FX space, the lower yields are helping to boost risk sensitive currencies, while JPY is also posting a relief rally after yesterday’s dovish BoJ decision sent it tumbling to lows that last spurred intervention.

While intraday price action remains choppy in most major FX pairs, we think today’s marginally more hawkish tone should be dollar supportive over the next few weeks, especially if the economic data continues to show robust growth momentum and labour demand.


Simon Harvey, Head of FX Analysis


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