The Federal Reserve’s FOMC committee decided to cut its key rate by 0.25 percentage points to a target range of 3.75% to 4.0%, and to fade its quantitative tightening—otherwise known as the reduction of its balance sheet—in November, and stopping the reductions on 1 December.

By delivering these two measures, the FOMC committee met all market expectations. However, during the press conference, Fed Chair Jerome Powell made statements that another rate cut in December is not a done deal. He stated, “in the committee’s discussion at this meeting, there were strongly differing views about how to proceed in December” and added “a further reduction in the policy rate at the December meeting is not a foregone conclusion – far from it.”

The hawkish shift in tone let the markets reprice sharply the probability of a December rate cut

This led the stock market to weaken, US treasury yields to surge, and the US dollar to appreciate, as the market sharply revised down the probability of another interest rate cut—from about 90% before the Fed’s decision to below 70% after Powell’s comments.

The reaction was supported by Powell's opening remarks at the press conference, showing a change in noting that “growth in economic activity may be on a somewhat firmer trajectory than expected”.

Interestingly, there were two dissenting votes on this decision, but otherwise all members were in agreement. Powell managed to secure a virtually unanimous decision among his colleagues. And while FOMC newcomer Stephen Miran once again voted for a larger rate cut of 0.5 percentage points, he was offset by regional Fed President Jeffrey Schmid, who voted to keep rates stable at 4% to 4.25%.

It also appeared that the combination of lingering worries of more “cockroaches” in the US banking system and more economic activity potentially adding to the already existing price pressures caused markets to forget the positive effects of an earlier stop of QT.

What will we monitor now?

We will closely monitor how the Fed's decision, Powell's statements, and upcoming economic and liquidity data shape market inflation expectations. Our attention will also turn to whether the announced end of quantitative tightening and a possible rebound of organic balance sheet growth help ease money market strains and reduce signs of liquidity stress, such as banks’ use of the Fed’s repo facility. With markets sharply repricing the odds of a December rate cut, the ongoing government shutdown leaves investors and policymakers “dancing in the dark,” as much of the usual economic data is unavailable. As Powell put it, “What do you do if you are driving in the fog? You slow down”. For now, both the Fed and markets will need more data to judge the economy’s direction — and another rate cut in December, in Powell’s words, is “not a foregone conclusion – far from it.”