(Bloomberg) — Federal Reserve Chairman Jerome Powell’s first press conference of 2019 left market expectations for an interest-rate hike this year hanging by a thread, and raised the chances of a cut in 2020.
A move to tighten policy in March was already seen as a long shot, but the Fed’s tone on Wednesday cast doubt on the prospects of any rate increase this year, after nine hikes since 2015.
A stronger focus on risks to the global outlook, the Fed’s emphasis on tighter financial conditions and Powell’s comments pushed two- and five-year Treasury yields to the lowest since mid-January. Shorter maturities led gains, steepening the yield curve. The spread between five- to 30-year yields expanded to 57 basis points, the widest since February, before trading at 54 basis points in Asian trading.
Another sign of waning prospects for a rate hike this year was the drop in near-dated implied volatility on swaptions — options on U.S. interest-rate swaps — which dropped to the lowest since November for one- to two-year contracts.
“The market is very aggressively discounting any positive outcomes this year” in areas such as domestic growth, trade and the global economy, said Ed Al-Hussainy, a senior interest-rate strategist at Columbia Threadneedle.
The Fed’s tone toward its policy rate and balance sheet is significant, he said. “The language and the markers they put down all point to a very elevated probability that the December hike was the last hike in the cycle.”
Market watchers were surprised by the Fed’s latest signals on its balance-sheet unwind, which suggests the central bank is closer to completion than previously expected. For traders, the Fed’s line that it’s “prepared to adjust any of the details for completing balance sheet normalization” confirmed a shift in a policy unwind that’s roiled markets.
“I am recovering from monetary-policy whiplash,” Omair Sharif, an economist at Societe Generale (PA:), wrote. “The bar for hiking rates even once in 2019 is extremely high.”
Rates traders cut what little positioning remained for a hike in 2019, and are gaining confidence in a 2020 easing.
Capital Economics senior economist Michael Pearce still expects one more increase from the Fed in the first half of 2019, based on solid economic data and easier financial conditions.
“But we would place far more emphasis on our forecast for a sharp slowdown in economic growth further ahead, which we expect will force the Fed to cut rates by 75bp in 2020,” he said in a report after Powell’s press conference.
(Updates yield spread in third paragraph, adds volatility in fourth.)
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