By Michael O’Neill

“Mission Accomplished.”  George W Bush delivered a speech under a banner with that sentiment aboard the USS Abraham Lincoln on May 1, 2003, when he proclaimed the end of the  US-Iraq war.  Except, it wasn’t. It took the rest of the Mr Bush’s term and half of President Obama’s first term before the last soldier left Iraq on December 18,2011.

Turns out, wrapping up wars and reining in inflation are birds of a feather, both are notorious for their “lag-effect” The Fed raised its benchmark rate 11 times before pausing in September and again in November 2023. The hikes were to battle rising inflation, and the pauses occurred partly due to the “lag-effect” of the monetary policy change on the economy.

The September meeting included the dot-plot projections, which suggested one more rate hike was likely before the end of the year. A series of strong US economic data followed, including two far-better-than-expected reports, September nonfarm payrolls and Q3 GDP. In addition, US Treasury yields started climbing, with the 10-year yield rising from a low of 4.36% on September 20 to 5.02% late in October.

The fact that the Fed left rates unchanged at the November 1 meeting was not a surprise to most. The statement struck a Goldilocks balance, but it did shift the job gains from “slowed” to “moderated” — a subtle change that left market watchers pondering whether it was a hawkish signal or a dovish coo.

However, what got traders excited was the reference to tighter financial conditions, which they took to mean that the rise in bond yields removes the necessity to raise rates any higher.

It was as if Mr. Powell yelled “Release the Hounds” because stock prices took off like a pack of dogs looking to feast on a plump and juicy squirrel.

The US dollar tanked, and equity indexes soared in the twenty-four hours following the FOMC meeting, but before you get your dancing shoes on, this could be a George W moment.

For starters, the catalyst for the FX and equity moves is the belief that the high bond yields have eliminated the need for further tightening. That may have been the case a few days ago when the US 10-year Treasury yield was bouncing around in a 4.90-5.0% range. The day after the Fed meeting, the 10-year Treasury yield is sitting at 4.67%. And even with the sell-off, the 2’s-10’s yield curve is still inverted, albeit a lot less than it was.

On October 27, the Core-personal consumption expenditures price index data showed a 0.3% rise in September, and the August-September trend is pointing higher, and it seems counter-intuitive to expect the index to decline heading into the Thanksgiving and holiday season.

If the latest statement was truly dovish enough to justify the market reaction, Mr. Powell would not have emphasized that the Fed still had a long way to go before inflation would reach its 2.0% target. He did not preclude further tightening and stressed the persistent inflationary pressures in the economy and ongoing strong labour demand.

We have seen this movie before. Last March, traders and analysts drooled with the anticipation of interest cuts beginning in September. That didn’t happen.

The Jerome Powell Fed has a lousy track record forecasting the economy. Last week, JPMorgan Chase CEO Jamie Dimon pointed out that central banks were 100% wrong 18 months ago (remember transitory inflation) and said he would be “quite cautious about what might happen next. When it comes to the Fed and its predictions, all markets participants should be embracing the proverb “once bitten, twice shy.”

Canadians shouldn’t be smug. The Bank of Canada (BoC) hasn’t performed any better.

Last week’s BoC monetary policy meeting was rather ambiguous. The statement warned that inflationary risks have increased since the last assessment, and CPI is expected to average around 3½% until mid-next year, higher than previously expected. It also said that inflation is expected to gradually ease and return to the 2% target by 2025, claiming that higher interest rates are already moderating spending and relieving price pressures, particularly in categories influenced by credit purchases.

Unlike the Fed, the BoC didn’t miss the elephant in the room — geopolitics.

The Russian-Ukraine war can escalate easily, especially if Western weapons continue to wreak havoc on Russian forces. Mid-East tensions are simmering as Iran’s theocratic rulers  and their proxy terrorist groups risk trouble to Tehran, while China’s muscle-flexing in Taiwan and the South China Sea can easily go pear-shaped.

As the U.S. dollar does the limbo, the loonie is more of a bystander, watching the U.S. economic drama unfold against the backdrop of these global tensions. Sure, USDCAD took a breather, dipping from 1.3900 to 1.3765, but don’t bet the farm until it plummets past 1.3570 — that’s when you know the trend has truly flipped.

So, the Fed’s not hanging up its boots just yet. As Powell quipped, there’s still “more work to do.” Consider this their coffee break, not a swan song.

(All Pictures generated by Bing Image Creator)