No suspense in pausing rate hikes? Tonight, focus on the Federal Reserve

Tonight, the Federal Open Market Committee (FOMC) of the Federal Reserve will announce its November interest rate decision, and it is almost a foregone conclusion that it will continue to hold on to it, while as financial conditions continue to tighten further due to the continued surge in Treasury yields, most Wall Street investment banks believe that the current rate hike cycle is over, and the debate turns to how long interest rates should remain at the current restrictive level.

At 14:00 EST on Wednesday, November 1 (02:00 a.m. Beijing time on Thursday, November 2), the Federal Reserve will announce its November interest rate decision, followed by Fed Chairman Jerome Powell's monetary policy press conference.

Wall Street's major investment banks agree that the Fed will continue to keep interest rates unchanged, becoming the first time since the current rate hike cycle that there has been no rate hike for two consecutive months, and the main focus of the market will be on Powell's subsequent press conference.

At the same time, the probability of a rate hike in December has also fallen slightly in recent days, and more investors have begun to bet that the Fed has "stopped raising interest rates".

Analysts widely expect the policy statement and Powell's press conference to release a neutral attitude, both emphasizing that the fight against inflation is not over and leaving the door open for further rate hikes, but also signaling that there is no rush to raise interest rates again and will remain patient to continue to assess future economic data.

Nomura economists believe that the impact of the surge in yields on the U.S. economy will be the main issue for the Fed as U.S. Treasury yields continue to be at record highs, and the current yield level is equivalent to two 25 basis point rate hikes by the Fed, so the current rate hike cycle is over.

But Barclays economists said that not every Fed official believes that the rise in Treasury yields means that the Fed has completed raising interest rates, and they believe that the FOMC will maintain a hawkish tone in the statement and eventually raise rates by another 25 basis points in December.

According to the latest CME Fed Watch data, there is a 97.7% probability that the Fed will keep interest rates unchanged in the 5.25%-5.50% range in November, and a 2.3% probability of a 25 basis point rate hike to the 5.50%-5.75% range. The probability of keeping interest rates unchanged by December is nearly 70%, the probability of a cumulative 25 basis point rate hike is about 30%, and the probability of a cumulative 50 basis point rate hike is 0.2%.

The resilience of the U.S. economy will also make the "last mile" of inflation reduction longer, and the market has postponed the pricing of the Fed's first 25 basis point rate cut until July 2024.

Three changes in the U.S. financial environment could see the Fed end its interest rate hikes

In the report, Nomura pointed out that since the September FOMC meeting, there have been three major changes in U.S. finance, and the gradual tightening of financial conditions may keep the Fed on hold.

First, U.S. economic data remained strong. Last week, the United States announced the third quarter of the United States real GDP annualized quarter-on-quarter preliminary growth of 4.9%, the growth rate of the second quarter of 2.1% more than double, exceeding market expectations of 4.7%, showing that the third quarter economic growth rebounded significantly compared with the first half of the year, other data, by the increase in aircraft demand, September durable goods new orders increased sharply by 4.7% month-on-month, October Markit manufacturing PMI preliminary value shows that the manufacturing boom back to the expansion range.

Second, inflation is facing greater resistance to cooling, and inflation expectations have rebounded. The PCE price index for September, which was released last week, fell back to 3.4% year-on-year, but the month-on-month growth rate was flat at 0.4%, and the core PCE fell back to 3.7%, and the month-on-month growth rate rebounded to 0.3% from 0.1% in the previous month. In a month-on-month sense, inflation is still sticky.

In addition, the University of Michigan's 1-year consumer inflation expectations for October, released last week, jumped sharply to 4.2% from 3.2% in the previous month, and long-term inflation expectations also rose to 3.0% from 2.8% previously, indicating that consumers believe that inflation may not come back in the future.

Third, Treasury yields have risen sharply, leading to a marked tightening of financial conditions. Over the past month, the 10-year Treasury yield has continued to rise, hitting a high of 5%. The rise in interest rates and the intensification of geopolitical conflicts have led to increased investors' concerns about the economic outlook, and the three major U.S. stock indexes have continued to fall, and financial conditions have tightened significantly.

For the Fed, rising market interest rates have reduced the need for further tightening, with Fed officials, including Jerome Powell, suggesting that higher Treasury yields could be a substitute for a rate hike to some extent.

San Francisco Fed President Mary Daly has previously said that higher Treasury yields have done part of the Fed's job, amounting to a rate hike, and may not need to tighten policy further.

Overall, Morgan Stanley noted that although the current US economic activity remains strong, the Fed is not expected to see an improvement in the economic outlook in its interest rate statement. The FOMC has been emphasizing that "tighter credit conditions could weigh on the economy", and now that economic conditions have tightened further, the Palestinian-Israeli conflict has added to the uncertainty. The FOMC's statement is likely to contain: "The impact of the Israeli-Palestinian conflict on the U.S. economy is very uncertain, but in the short term, conflict-related events could lead to additional upward pressure on energy prices, dragging down economic activity."

How did Powell respond at the press conference?

Analysts generally believe that Powell will be asked by reporters whether he agrees with the committee's September forecast that there will be another rate hike before the end of the year. He is likely to say that future rate hikes are still data-dependent, that there is a lag in the role of monetary policy, and that the economy has not yet felt the full impact of rate hikes.

Nomura pointed out that overall, strong economic data still poses a risk to inflation, and Powell cannot give up the hawkish tone yet, but the tightening of financial conditions may make the Fed more cautious.

Morgan Stanley expects the tone of Powell's speech to be similar to that of his speech at the Economic Club of New York: there are risks to the economic outlook, and since the September FOMC meeting, our financial conditions have tightened, equivalent to a 75 basis point rate hike by the Fed:

We expect Powell to reiterate that uncertainty in the environment ahead will complicate the task by balancing the risk of overly tight monetary policy with the risk of easing.

How do U.S. stocks go?

Investors are no strangers to the "seesaw" relationship between U.S. stocks and U.S. Treasury yields. In August, the yield on the 10-year Treasury note soared from 2.6% to above 4% in less than three months, and last year the US stock market hit its worst year since 2008, weighed down by the Federal Reserve's continued interest rate hikes and recession expectations. A year later, Treasury yields rose again in July this year, quickly breaking through 5% from 3.8% in a short period of time.

As of Oct. 27, 49% of S&P 500 companies have reported third-quarter earnings, and 78% of companies have earnings per share that beat market expectations, slightly higher than the five-year average of 77%, according to financial data firm FactSet. However, Meta and Google, which are among the top companies by market capitalization, fell 7% and 12% respectively in the two days after the release of the list.

Peter Oppenheimer, chief global equity strategist at Goldman Sachs, said that the U.S. stock market is currently facing greater and more concentrated risks compared to other major markets, and as U.S. Treasury rates rise, cash and fixed income become more attractive, and the situation in which the U.S. stock market has significantly outperformed other markets in the past 10 years is unlikely to repeat itself in the next 10 years:

The outperformance of U.S. stocks partly reflects the dominance of the U.S. in the technology sector and the domination of U.S. stocks by a few tech giants. The stock market also accounts for a much higher share of the U.S. economy than elsewhere, and investors should diversify their investments now.

As other assets such as cash and fixed income are more attractive, they will discourage the market from holding stocks.