Stock Markets After Fed’s Dovish Rate Hike

Yesterday, the Federal Reserve
Open Market Committee (FOMC) under the leadership of Jerome Powell concluded
the final meeting of the year in which was dubbed as the most important day in markets.
This is because the decision placed the Fed between a rock and a hard place.
This is so because the Fed had initially guided for four rate hikes this year.
In recent weeks, Donald Trump has continued to apply pressure on the Federal
Reserve not to increase the borrowing costs. Therefore, the Fed had to balance
between following through the previous guidance or leaving rates unchanged.
Doing the latter would have exposed it to criticism that it caved in to
pressure from the US president. This is important because the Fed is supposed
to be independent.

To strike a balance between the
Fed’s independence and the recent data, the Fed issued what was known as a
dovish rate hike. In this, it increased rates but at the time lowered the
expectations of the coming year. Instead of the three rate hikes, the Fed
guided that it will hike two times. This was an expected move at a time when
recent data has not been very supportive. The chart below shows the Fed’s dot

In the statement, the Fed said

The labor market has continued to strengthen and that economic activity
has been rising at a strong rate. Job gains have been strong, on average, in
recent months, and the unemployment rate has remained low. Household spending
has continued to grow strongly, while growth of business fixed investment has
moderated from its rapid pace earlier in the year. On a 12-month basis, both
overall inflation and inflation for items other than food and energy remain
near 2 percent. Indicators of longer-term inflation expectations are little
changed, on balance.

The Fed also tweaked the language
of the statement saying that the FOMC ‘judges that some further gradual
increases will likely be needed.’ This was contrary to the previous statement
that said that the FOMC ‘expects that further gradual increases will be

What was interesting with this
statement is that it did not reflect the real data released in the past one month.
This month, jobs numbers showed that more than 150K people were employed in
October. However, this was lower than what the analysts were expecting. The
jobless claims have continued to rise. The same is true with the number of
people being laid off. The housing market has started to cool. The GDP has
slowed from the second quarter and the consumer and business confidence has
remained subdued.

Another important thing from the
meeting was that the Fed officials lowered the median estimate of the neutral
rate to 2.75% from 3%. The median guidance for the benchmark rate to end 2021
at 3.1%, which was lower from the previous estimate of 3.4%. The neutral rate
is one which facilitates full employment while at the same time keeping
inflation contained.

After the rate decision, the
dollar rose while the US indices declined as shown below.

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