The Fed has found its balance

02 November 2023

Dear clients,

There was a rally of calm in Asia on Thursday as investors become increasingly convinced that the next move in US interest rates will be directed downwards rather than upwards. All major Asian equity markets are rising, as are US and European stock futures.

Although Fed Chairman Jerome Powell kept alive the possibility of another rate hike, his voice sounded less than confident. Risks are now "more two-sided" and almost "balanced," he said in his remarks to the press. They are making progress on inflation and, importantly, inflation expectations are "in a good place."

That was enough for markets to reduce the risk of a December rate hike to 22% and a January rate hike to 28%. At the same time, the probability of a rate cut by next June has risen to nearly 70%, with futures now suggesting a rate easing of 85 basis points through 2024.

Powell has certainly downplayed the likelihood of a rate cut, but he must realise that with inflation steadily falling, real rates are rising. If the Fed does nothing at all, policy will actually tighten through next year despite the expected slowdown in the economy, increasing the risk of recession.

The Treasury bond market has played its part by pushing yields higher in recent weeks, and duly noted this by pulling them down again, at least for now. Ten-year bond yields are down 22 basis points from Wednesday's high of 4.71%, though that's still well above the 4.0% level reached in early August.

The 30-year bond yield fell back below 5%, helped by relief that Treasury's refinancing plans included less issuance over a longer interval than many had feared.

The next major hurdle for stocks will be the results of $2.7 trillion Apple after trading. The focus will be on iPhone 15 sales and whether the strong start to sales has been slowed by cooling demand in China. In addition, the outlook for the crucial festive season in the December quarter could play an important role.

Markets will now hope that Friday's payrolls report doesn't spoil the festivities.

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