Stocks rally, dollar tumbles, as Powell signaled to slow rate-hike pace in December

Once again, it was Jerome Powell, the Federal Reserve’s Chair, the one who moved financial markets. In a highly anticipated speech on Wednesday at the Brookings Institution, a think tank based in Washington, Powell signaled that the Fed is ready to slow the rate-hike pace as soon as December.

He talked about the economic outlook, inflation, and the labor market – all topics of extreme interest to financial market participants.                                                                                     

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All of a sudden, the FOMC Meeting scheduled in about two weeks from now is viewed as the one to mark the peak in Fed’s rate hikes. But financial markets rarely await confirmation.

Instead, they move in anticipation of what is about to come.

As such, while the Fed will keep increasing the interest rates, thus tightening financial conditions, the markets took it as a sign that the tightening cycle is about to end soon.

What did Powell say?

The main concern of the Fed is to avoid overtightening, given the time it needs for rate hikes to impact the economy. Also, labor-market imbalances are at the top of the list regarding Fed priorities when interpreting the economy.

In particular, wage growth remains well above levels that ensure inflation around the Fed’s target of 2%. Hence, this Friday’s data referring to wage growth for November is extremely interesting to market participants.

How did the markets react?

The markets reacted with a general frenzy as stocks rallied hard. Also, the US dollar dived, as reflected by the EUR/USD exchange rate moving back above 1.04 from below 1.03 a little earlier in the week.

The Dow Jones, for instance, gained more than 1,000 points following Powell’s remarks. So why did markets react like this, given that the Fed is still about to hike the funds rate by 50bp in December?

An answer would be that this is the pivot everyone was waiting for. If the Fed pivots as a leading central bank, it means that it sees signs that inflation is cooling off.

As a result, other central banks will follow suit, meaning that the peak of tightening might be behind.

All in all, a hawkish speech, given everything that happened in 2022 and how the Fed reacted to the challenges in fulfilling its mandate. It may be that the Fed has just set up the stage for a stock market Santa Rally.