Federal Reserve Chair Jerome Powell’s recent remarks have unsettled investors. Speaking on Thursday, Powell indicated that the Fed might pause its current cycle of interest rate cuts, leaving the market uncertain about the central bank's next steps. While stocks and bond markets reacted negatively, some economists interpret Powell’s comments differently, suggesting they may not signal doom for the markets.
Markets experienced turbulence following Powell’s remarks. The S&P 500 posted a 1.3% drop on Friday, marking its worst week since early September. Short-term bond yields climbed, and traders reduced their expectations for near-term rate cuts. Futures markets on Friday reflected a 40% chance of no rate cut in December, up from about 20% before the latest inflation data release and Powell’s speech.
The Federal Open Market Committee (FOMC) will meet again on Dec. 17-18, and traders are currently assigning a 60% probability to a quarter-percentage-point reduction in the federal funds rate during that meeting.
Andrew Hollenhorst, Chief U.S. Economist at Citi, noted that Treasury yields rose following Powell's comments. However, he argued that Powell's message was less hawkish than it appeared. “We see Powell’s remarks as preserving flexibility rather than signaling a hawkish stance,” Hollenhorst wrote. He added that Powell emphasized the need to support a labor market that remains soft and dismissed concerns that fiscal policy from the Trump administration would drive more aggressive Fed tightening.
Powell stressed that the economy’s current performance allows the Fed to take a measured approach. “The economy is not sending signals that we need to rush into lowering rates,” Powell stated during his speech in Dallas. He pointed to economic resilience as a reason for the Fed’s cautious stance.
The Fed last cut rates on Nov. 7, reducing the target range to 4.5%-4.75%. That move followed a half-point cut in September, which marked the beginning of this easing cycle after more than a year of holding rates steady.
Jan Hatzius, Chief Economist at Goldman Sachs, noted the potential for a slower pace of cuts going forward. “We still expect cuts in December, January, and March, with additional reductions in June and September,” Hatzius said. “However, there’s a growing chance the Fed could slow this pace, possibly as early as December or January.”
The path forward depends heavily on incoming data. The Fed would likely need to see surprisingly strong employment or inflation data in November to refrain from cutting rates in December. Both reports are expected in early December, adding another layer of anticipation ahead of the FOMC’s next meeting.
Powell’s remarks also touched on the concept of the “neutral rate,” an interest rate level that neither stimulates nor restricts economic growth. As the Fed moves closer to this neutral rate—which economists estimate to be around 3%—it may slow the pace of rate cuts to assess the economy’s response. Powell suggested that the neutral rate might be higher than current estimates, given the economy’s continued strength with rates near 5%. If that’s the case, today’s policy stance may be less restrictive than many assume.
Gerard MacDonell of 22V Research highlighted the uncertainty surrounding the neutral rate. “Powell has stepped back from the view that the funds rate is significantly misaligned with economic fundamentals and needs a sharp adjustment,” MacDonell wrote. “The reality is, neither Powell nor anyone else knows exactly what ‘normal’ is.”
Bond markets have reflected the evolving economic narrative. Yields on the 2-year U.S. Treasury note reached around 4.3% on Friday, marking a seventh consecutive week of increases and adding roughly 0.75 percentage points over that period. The rise in yields followed strong economic and inflation data, prompting traders to temper their expectations for an aggressive easing cycle.
The Fed’s updated Summary of Economic Projections (SEP), due in December, will provide fresh insights into policymakers’ expectations for the coming years. The September SEP pointed to a cumulative one percentage point of rate cuts each in 2024 and 2025. However, the December update may reflect adjustments based on recent economic conditions.
For wealth advisors and RIAs, these developments highlight the importance of recalibrating strategies to align with the Fed’s evolving policy stance. The prospect of a higher neutral rate suggests a potentially longer path to lower borrowing costs, influencing decisions in fixed income and equity allocations. Advisors should keep a close watch on labor market and inflation reports in the coming weeks, as these will be pivotal in shaping the Fed’s next steps.
While volatility may persist in the short term, Powell’s commitment to data-driven policy provides a foundation for cautious optimism. By maintaining flexibility, the Fed aims to balance economic growth with its inflation objectives, leaving the door open for adjustments as conditions evolve.
