Markets welcome a dovish pivot earlier than expected

The Fed raised rates by 25bps yesterday in line with market expectations. It wasn’t so much the hike that was perceived dovish but the statement that followed. It is clear the Fed is still focused on inflation but this is the most dovish tilt we have seen since the 2018/19 Fed pivot.  It is also clear that we are closer to the end of the hiking cycle, but the data is split with this continuation of labour market strength giving more hope of a soft landing.

The ratio of job openings to unemployed rose back to 1.9 –  a sign of continued strength in the labour market with job openings back to 11 million. If the Fed is truly data dependent, then Friday’s release of average hourly earnings and CPI will be interesting if they do not show what is expected. This may force the now dovish Fed to rethink their change in narrative.

Whilst Powell did say they needed “substantially more evidence that inflation is on a sustained downward path”, he didn’t push back on the possibility of 50bps cuts toward the end of 2023. These are in fact already priced into the market (along with a slightly lower terminal rate now at 4.9%). As I see this, the markets’ desperation for the duration trade is being gifted by a dovish Fed and this shift in overall narrative might just be telling us – once again – not to fight the Fed.

Meanwhile the ECB and BOE decision today potentially means further weakness for the USD, as the ECB has lead markets to think it is still on a hawkish path. However, the decision reminds us of one more key thing – not to rely on forward guidance.