One more time, financial markets entered a Federal Reserve meeting with a notion of reality that was different from what the Fed was looking at and, one more time, the Fed pushed back. Equity and bond bulls alike have been focused on how a weakening economy would continue to bring inflation under control and ultimately lead to rate cuts from the Fed before the end of the year. Even though this afternoon’s FOMC announcement delivered the quarter of a percentage point increase in the fed funds target rate to 4.75% that the street expected, the language of the accompanying statement squashed the goldilocks discussion of a pause and/or pivot.

 

 

I have been arguing for a while now that the Fed is not convinced that the inflation battle is over, simply because we have seen the headline rate fall from 9% to 6% or because the Fed’s favoured metric – the core PCE deflator – was moderating. The market thought that this, plus the slew of negative indicators from housing and manufacturing would sway Chairman Powell and crew into repeating the same mistake that the Bank of Canada just made, in stating that it was time for a pause.

 

What the market has missed repeatedly is that a labour market as tight as the what we see in the US, is not conducive to weaker demand. Jobless claims have been falling in recent weeks and, even though this Friday’s payrolls report might indeed come in as anemic as indicated in this morning’s ADP payrolls report, the fact that the JOLTS Job Openings report this morning showed a resurgence back above 11 million tells us things are still pretty robust.

 

In reading through the FOMC statement, here are the tidbits that investors need to be aware of. First, it acknowledges that inflation “has eased somewhat but remains elevated”. It left in its comment that “in determining the extent of future increases in the target range …”.  In other words, if there is any feeling at the Fed that a pause is warranted at its March or May meetings, it wouldn’t have left this reference to “future increases” in the statement. Even if we only get one more move, that takes the rate to 5% and I would not rule out a return to 5.25% - the peak before the Financial Crisis. Shorter-term bond yields were volatile today and may be pushed higher in the wake of the meeting. Even though stocks sifted through Powell's press conference and decided to trade on his acknowledgement of disinflation, they seemed oblivious to the statement he made shortly after, that he does not see the Fed cutting rates this year. Stocks bounced off their lows, but I would be extremely cautious about reading too much into it.  

 

This is also going to put some pressure on the Bank of Canada and raise the question again – why talking about pausing before seeing what the Fed was thinking. For now, I expect that this will put downward pressure on the Canadian dollar below 75 US cents. The language from the FOMC today validated the risk we have been highlighting since the start of the year, that rates can still move higher and, more importantly, stay elevated longer.  

 

On behalf of the Pyle Group, have a great rest of the day.   

Andrew Pyle

 

 

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These are the personal opinions of Andrew Pyle and the Pyle Group and may not necessarily reflect those of CIBC World Markets Inc.