The market and economists are pretty much unanimous in expecting the Fed to hold rates unchanged in the upcoming FOMC rate decision on Wednesday. That had been the forecast for quite a while. The big change, however, happened with the stronger than expected jobs report on Friday. However, the fact the dollar didn’t gain in the aftermath shows that a “good news is bad news” scenario seems to be playing out in the markets.
Up until Friday, markets were expecting a hold on Wednesday followed by a rate cut at the June meeting. Usually, ahead of a major FOMC rate decision, the Fed likes to give the markets a bit of an advance warning before making a policy move.. That means that there was considerable speculation that the Fed would anticipate a June meeting in its statement this week, or in the post rate decision presser by Chair Jerome Powell. The change in market sentiment implies that traders are now expecting a repeat “wait-and-see” rhetoric, implying rates will stay higher for one more month.
Up is Down and Down is Up
When there is a lot of expectation around the Fed, markets can start acting counterintuitively. That’s because as the situation worsens, the central bank is expected to step in to prove support. Usually in the form of lower interest rates, and if things are particularly bad, buying bonds. But, if the economic situation is better than expected, the markets can react negatively. That’s because it decreases the chance of the Fed providing what is effectively a stimulus.
That likely explains the market’s surprising dynamics last week, where there was better optimism after the US Q1 GDP figure unexpectedly came in negative. Then, when the jobs report came out, markets were not impressed with safe havens like gold seeing gains after the weekend.
Sussing Out the Market Reaction
Making things more difficult for analysts, there are a lot of moving parts to the story. For a couple of weeks, US President Donald Trump let the notion of firing Powell hang in the media commentariat. After ruling it out a week ago, he once again confirmed over the weekend that Powell would remain in the top spot until his term ends. However, Trump has been quite adamant about lowering rates, and it might have been part of a pressure tactic to deliver on his policy preference.
Trump is far from the only one wanting the Fed to lower rates. Several confederations of industry have petitioned the Fed to start easing, as they face increased difficulties due to the trade war. A negative print in GDP also puts pressure on the central bank to ease. Even if inflation is high now, it takes some time for the policy to have an effect. If the Fed waits too long, then pressures can switch to deflationary and raise the risk of undershooting the inflation target.
What to Look Out For
After the last meeting and in his public appearance since then Powell has largely stuck to the line that tariffs will likely be bad for the economy and raise inflation. How much of which will be the result is something there isn’t enough data to predict at this moment, so the Fed will stay in a holding pattern. Other FOMC members have expressed similar sentiments as well.
What could cause a market reaction is if there is a change in that general theme either in the statement (less likely), or in Powell’s press conference (more likely). Such as, for example, expressing concern that inflation might undershoot. This could bring back hope for a rate cut at the next meeting. As of now, however, the market sees only about a third of a chance of that happening.
