U.S. stocks rallied this week and the S&P 500 posted its single best day in roughly eight months, welcome news to investors struggling through recent volatility. Some of this performance may be tied to G20 summit optimism and cheaper starting valuations. However, most credit is probably due to comments made by Federal Reserve chair Jay Powell at the Economic Club of New York.
When speaking in New York, Chair Powell remarked that current U.S. interest rates “remain just below the broad range of estimates of the level that would be neutral for the economy." With the level and direction of interest rates one of the most pressing near-term issues for U.S. investors, a more dovish Fed tone took some pressure off of U.S. stocks. The comment’s impact was further amplified by its direct contradiction of earlier rhetoric: two months ago in an onstage conversation with Judy Woodruff of PBS, Chair Powell remarked on interest rates, “we’re a long way from neutral at this point.”
So, what has changed? Perhaps, November’s comments were different because they were prepared, rather than off-the-cuff. But it is also worth noting that the Fed governors and bank presidents maintain their own view of neutral, centered on 3.0%. It may well be, then, that Chair Powell’s view has not changed as much as his comments would suggest: if the neutral rate is indeed close to 3.0%, then differences in comments may simply be semantics. In short, markets may have overreacted.
Nonetheless, markets clearly assume that the Fed will move at a slower pace next year than initially feared. Indeed, as shown in the chart below, market expectations for the December 2019 federal funds rate have fallen sharply to roughly 2.7%, implying just over two rate hikes between now and the end of next year. (It should be noted, though, that market expectations have consistently suggested a dovish view of Fed policy: for example, participants on December 31, 2017 expected just under three rate hikes for 2018, and now most strategists believe we will get four). In the end, our view has not changed: the Federal Reserve will hike three more times between now and June of next year before pausing in the back half of 2019.
Markets have become more dovish on interest rate expectations
Federal Funds Rate futures contract yield, expiring December 2019
Source: Source: Bloomberg, Federal Reserve, J.P. Morgan Asset Management. Data are as of November 30, 2018.