How Markets Reacted to the Fed’s Decision to Keep Interest Rates Unchanged
The Federal Reserve announced on Wednesday, February 14, 2024, that it would keep its benchmark interest rate unchanged at 5.25%-5.50%, as it continues to monitor the inflation and growth outlook. The decision was widely expected by market participants, who had priced in a low probability of a rate cut at this meeting. However, the Fed also signaled that it was open to adjusting its policy stance in the future, depending on the incoming data and the evolution of the economic situation.
The Fed’s statement acknowledged that inflation had moderated somewhat since its last meeting in December, but remained above its 2% target. It also noted that the labor market had strengthened further, with solid job gains and a low unemployment rate. However, it also pointed out some downside risks to the outlook, such as the ongoing trade tensions, the slowdown in global growth, and the uncertainty surrounding the fiscal policy.
The Fed said that it would continue to assess the appropriate path of the federal funds rate, and that it would be patient in making future adjustments. It also reiterated that it would continue to reduce its balance sheet at a gradual and predictable pace, as it unwinds the stimulus measures it took during the financial crisis.
The market reaction to the Fed’s decision was mixed, as different asset classes responded differently to the Fed’s tone and guidance. Here are some of the main highlights:
- Stocks: The U.S. stock market initially rose after the Fed’s announcement, as investors welcomed the Fed’s patience and flexibility. However, the gains were short-lived, as the market soon turned lower, amid concerns about the global growth outlook and the ongoing trade disputes. The S&P 500 index closed down 0.5% on Wednesday, while the Dow Jones Industrial Average fell 0.6% and the Nasdaq Composite dropped 0.7%.
- Bonds: The U.S. bond market rallied after the Fed’s decision, as bond prices rose and yields fell. The yield on the 10-year Treasury note, which moves inversely to its price, declined by 8 basis points to 4.02%, its lowest level since November 2023. The yield on the 2-year Treasury note, which is more sensitive to the Fed’s policy moves, fell by 6 basis points to 4.76%. The yield curve, which measures the difference between the long-term and short-term yields, flattened slightly, as the market reduced its expectations of future rate hikes.
- Currencies: The U.S. dollar weakened against most of its major peers, as the Fed’s dovish stance reduced the appeal of the greenback. The euro rose 0.4% against the dollar to 1.1726, while the British pound gained 0.3% to 1.3214. The Japanese yen, which is seen as a safe-haven currency, also appreciated 0.4% to 109.76 per dollar. The Chinese yuan, however, slipped 0.2% to 6.7894 per dollar, as the trade talks between the U.S. and China remained unresolved.
- Commodities: The commodity market was mostly higher, as the weaker dollar and the lower interest rates boosted the demand for raw materials. Gold, which is often used as a hedge against inflation and currency fluctuations, rose 0.9% to $1,344.50 per ounce, its highest level since April 2023. Oil, which is influenced by the global growth and supply outlook, also advanced 1.2% to $64.32 per barrel, as the OPEC and its allies agreed to extend their production cuts until June 2024.
What are the Market Expectations for Future Interest Rates?
The Fed’s decision to keep interest rates unchanged did not alter the market expectations for future interest rates significantly, as the market had already anticipated this outcome. However, the Fed’s statement and the subsequent comments from Fed officials did provide some clues about the possible direction and timing of the next policy move.
According to the CME FedWatch Tool, which tracks the market-implied probabilities of FOMC rate moves based on the 30-day Fed Funds futures pricing data, the market expects the Fed to remain on hold for the next few meetings, and then start cutting rates gradually later in the year. As of February 15, 2024, the market assigns a 90% probability that the Fed will keep the rate unchanged at 5.25%-5.50% at its next meeting on March 20, and an 80% probability that it will do the same at its following meeting on May 1. The market then assigns a 60% probability that the Fed will cut the rate by 0.25% to 5.00%-5.25% at its meeting on June 12, and a 40% probability that it will cut it by another 0.25% to 4.75%-5.00% at its meeting on July 31. By the end of the year, the market expects the Fed to lower the rate to 4.25%-4.50%, with a 70% probability.
The market expectations for future interest rates are also reflected in the yield curve, which shows the relationship between the yields and the maturities of different Treasury securities. The yield curve is often used as a predictor of the economic outlook, as it incorporates the market’s expectations of inflation, growth, and the Fed’s policy. A normal yield curve is upward-sloping, meaning that the long-term yields are higher than the short-term yields, as investors demand a higher return for lending money for a longer period of time. A flat yield curve means that the long-term and short-term yields are equal, indicating that the market expects the economy to grow at a steady pace, with no major changes in inflation or the Fed’s policy. An inverted yield curve means that the long-term yields are lower than the short-term yields, signaling that the market expects the economy to slow down, with lower inflation and lower interest rates.
As of February 15, 2024, the yield curve is slightly upward-sloping, but flatter than it was a year ago. The yield on the 10-year Treasury note is 4.02%, while the yield on the 2-year Treasury note is 4.76%, resulting in a positive spread of 26 basis points. A year ago, the spread was 72 basis points, as the 10-year yield was 4.10% and the 2-year yield was 4.38%. The flattening of the yield curve suggests that the market expects the Fed to cut interest rates in the future, as the economy faces some headwinds from the trade tensions, the global slowdown, and the fiscal uncertainty. However, the yield curve is not inverted, meaning that the market does not anticipate a recession or a deflationary scenario.
The market expectations for future interest rates are not set in stone, and they can change depending on the new information and developments that affect the economic outlook and the Fed’s policy. The Fed itself does not follow the market expectations, but rather makes its decisions based on its own assessment of the economic conditions and the inflation and growth projections. Therefore, investors should be prepared for the possibility that the Fed may surprise the market with its policy actions, either by being more hawkish or more dovish than expected, and that the market may react accordingly, either positively or negatively.
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