The US stock market closed significantly lower on Wednesday on the last trading day of January. The Federal Reserve maintained interest rates unchanged in its January resolution released on the same day, but Federal Reserve Chairman Powell clearly undermined hopes of a rate cut as early as March. In the end, the three major stock indexes in the United States plummeted across the board, with the S&P 500 index experiencing its largest daily decline since September 21st, and the Nasdaq falling more than 2%.
It is worth mentioning that this is also the worst performance of US stocks since March last year on the Federal Reserve's interest rate day.
The 11 major sectors of the S&P 500 index were ultimately wiped out overnight, with communication services and technology stocks experiencing the largest decline, and the "seven giants" of the US stock market also experiencing their worst day since December last year.
In the bond market, overnight US treasury bond bonds have once again continued the rule of "rising more than falling" before and after the resolution of the Federal Reserve in recent years. But the rise in US Treasury bonds this time is clearly not much related to the Federal Reserve's January decision - the lower than expected small non farm ADP employment report released in early trading on Wednesday in New York, as well as the risk aversion triggered by the explosion of New York Community Bank financial reports, are the main drivers of the rise in US Treasury prices (yield decline).
However, after the Federal Reserve's resolution was released, especially after Powell's speech, the yield on US Treasury bonds at various maturities actually narrowed some of the intraday declines. As of the end of the New York session, the 2-year US Treasury yield fell 12.4 basis points to 4.221%, the 5-year US Treasury yield fell 13.3 basis points to 3.841%, the 10-year US Treasury yield fell 12 basis points to 3.917%, and the 30-year US Treasury yield fell 8.2 basis points to 4.171%.
Meanwhile, in the foreign exchange market, driven by Powell's overall hawkish sentiment and market hedging sentiment, the US dollar index further rose on Wednesday, rising 0.26% to 103.66 in late trading. From a monthly performance perspective, the US dollar index has risen by approximately 2.3% in the first month of the new year, marking the best monthly performance since September last year.
So, what exactly happened last night, the first Federal Reserve resolution night of 2024, to the extent that the US market was in a state of panic? What specific signals has the Federal Reserve released regarding the prospects of interest rate cuts and balance sheet tightening this year?
Federal Reserve's Night Review of Interest Rate Negotiations
In fact, after reading through last night's Federal Reserve resolution, the core message that Powell and his colleagues want to convey is still quite clear: that interest rates will eventually be lowered, but we don't want the market to anticipate too early; We will also start discussing table reduction, but we are not in a hurry to make a decision at the moment.
In other words, the Fed's overall tone still affirms the next shift in easing, but compared to the overly enthusiastic interest rate cut bets in the market before, it is clearly not as aggressive.
In the monetary policy statement released at 3am on Thursday, the Federal Reserve made significant changes. The Federal Open Market Committee stated in a statement, "The committee determines that the risks of achieving employment and inflation targets are moving towards a more balanced direction. When considering any adjustments to the federal funds rate target range, the committee will carefully evaluate the upcoming data, changing prospects, and risk balance."
As mentioned in our forward-looking statement, the Federal Reserve has removed statements about potential interest rate hikes and made a more neutral assessment of its future policy path.
But it seems that in order to prevent people from interpreting it as a dove, Federal Reserve officials have clearly emphasized that there is no rush to lower interest rates. The statement stated, "We do not believe that lowering the interest rate target range is appropriate until we are further convinced that inflation is sustainable towards the 2% target."
In the interest rate statement, Federal Reserve decision-makers also made minor adjustments to the description of economic activity. After the US economy grew beyond expectations in the fourth quarter, FOMC described economic activity as "expanding at a steady pace.". The last statement stated that "recent indicators indicate that economic activity has slowed down compared to the strong pace in the third quarter.".
This change is actually not surprising - as we have mentioned multiple times before, since the beginning of the year, various indicators including GDP, non-agricultural, and retail sales have all shown that the US economy is still hot. If the Federal Reserve continues to emphasize the slowdown of economic activity, it will completely contradict the situation revealed by the data.
Of course, the most dramatic change in last night's Federal Reserve resolution may not have been anticipated by anyone beforehand - since March last year, the Federal Reserve has consistently mentioned the stability and resilience of the banking system and warned that tightening the credit environment may put pressure on economic activity, but these statements have been removed from the latest statement.
At present, it is unclear why the Federal Reserve removed the phrase "the banking system is stable and resilient" due to certain considerations. Perhaps it is because it believes that after the announcement of the Bank Term Financing Program (BTFP) rescue measure, which will expire in March, there is no need to mention the US banking industry again? Or perhaps it is really discovering that there are problems with the banking system?
However, regardless of the cause, what happened last night was that shortly before the Federal Reserve deleted this sentence, New York Community Bank unexpectedly exploded in its financial report. The bank's stock price plummeted by 46% during trading on Wednesday, leading to a major drop in US regional bank stocks.
It is reported that in order to cope with loan risks (including two non-performing loans including a cooperative apartment and an office building) and stricter regulation due to its size, New York Community Bank has hoarded a large amount of cash. Its loan loss reserve surged to $552 million, shocking analysts and shareholders. The analyst's previous estimate was only $45 million, which means the loan reserve exceeds the analyst's estimate by more than 10 times and also exceeds the company's total reserve over the past decade.
In a sense, whether it is the overnight drop in US stocks or the surge in US bonds, the impact of the resurgence of regional banking crisis panic in the US seems to be no weaker than the Federal Reserve's decision. Because even though Federal Reserve Chairman Powell delivered a hawkish speech overnight, US Treasury yields ultimately experienced a sharp drop throughout the day - rather than a sharp rise. As for the US stock market, both events were huge bearish for stock market investors last night.
Powell hits expectations for a March interest rate cut
Compared to the significant changes made overnight in the Federal Reserve's monetary policy statement, Federal Reserve Chairman Powell stood in stark opposition to investors betting on a rate cut in March at Wednesday's press conference.
Powell stated that at least based on Wednesday's meeting, the confidence level of the Federal Reserve in starting interest rate cuts in March has not yet been reached, and whether to ultimately cut rates will depend on the evolution of the economic situation. Theoretically, the United States is in the stage of "surviving the COVID-19 epidemic economy".
When asked if the Federal Reserve has achieved a soft landing, Powell said he "wouldn't say we have achieved it.". A soft landing refers to a situation where inflation slows down but does not trigger an economic recession. Powell pointed out that "we still have a way to go" because core inflation is still above the Federal Reserve's 2% target. "We are encouraged by the progress, but victory will not be announced yet."
Powell believes that the current supply chain has not yet returned to its original state, and the recovery of the supply chain may still be a tail risk. Further economic growth should be attributed to the recovery of the supply chain. The greater risk is that US inflation may stabilize above 2%.
It is obvious that Powell made it relatively clear that the March interest rate cut was not the Fed's "basic scenario" expectation. According to the latest pricing in the interest rate market, after Powell's speech, the market currently expects a probability of about 35% for a rate cut in March, far lower than the 73% a month ago. Meanwhile, the futures market now reflects a nearly 90% chance of a rate cut in May.
"If stock bulls had originally expected a rate cut in March, then it seems like Powell has closed the door," said Oscar Munoz, strategist at Daoming Securities
At present, Goldman Sachs has postponed its expectation of the first rate cut to May as soon as the Federal Reserve's decision was made. Prior to the decision, the bank had predicted that the Federal Reserve would cut interest rates for the first time in March. Meanwhile, Goldman Sachs still expects to cut interest rates 5 times in 2024 and another 3 times in 2025.
In addition to the highly anticipated topic of interest rate cuts in the industry, Powell also stated on Wednesday that Federal Reserve decision-makers plan to begin in-depth discussions on slowing down or ultimately stopping balance sheet reduction during their March meeting.
"As this process continues, we are approaching a point where questions about the pace of balance sheet reduction are beginning to receive greater attention, and we plan to begin in-depth discussions on balance sheet issues at our next meeting in March," Powell said.
In the past year and a half, the Federal Reserve has allowed up to $60 billion of US treasury bond bonds and up to $35 billion of institutional bonds to flow out of the balance sheet due to maturity every month. However, there is increasing discussion in the market about whether the Federal Reserve has misjudged to what extent it can shrink its balance sheet without causing a shortage of reserves in the financial system.
Powell also mentioned on Wednesday that there is no need to wait until the overnight reverse repurchase agreement (RRP) is completely reduced to zero before slowing down the process of balance sheet reduction. At present, the usage of the Federal Reserve's overnight reverse repurchase tool has rapidly shrunk to about $577.6 billion at the beginning of the new year. The Federal Reserve's overnight reverse repo tool can be understood as a reservoir of idle funds for non banking institutions, where the Monetary Fund stores cash and can also act as a buffer for bank reserves.
Regarding the overnight Federal Reserve decision, Karl Schamotta, Chief Market Strategist at Corpay in Toronto, said that the Federal Reserve issued a "very neutral and non commitment statement.".
Keith Lerner, Chief Market Strategist at Trust Wealth, pointed out that "Powell has retained some flexibility and is still providing direction for the Federal Reserve to shift towards a more accommodative stance. The market is volatile, but overall this is expected and there has been no significant shift."