For the market, is a "dovish pause" by the Fed in December better than a "hawkish rate cut"?
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Recent intensive statements from Federal Reserve officials have boosted expectations of a rate cut, and Bank of America believes that facing severe internal divisions, a "dovish pause" would be wiser.
Following New York Fed President Williams’ dovish signal, Fed Governor Waller explicitly stated his support for a December rate cut on Monday. These remarks greatly buoyed market sentiment, with the probability of a December rate cut surging from a low level to 80%. The S&P 500 closed up nearly 1.6%, the biggest gain in six weeks, while the Nasdaq closed up 2.7%, its best single-day performance since May.
However, Bank of America warns that there are serious divisions within the Fed regarding the December decision. BofA economists Aditya Bhave and Matthew Yep warned in a November 24 report that these dovish voices are far from representing committee consensus. Fed Governor Barr stressed the need to "act cautiously," Chicago Fed President Goolsbee focused on upside inflation risks, and Dallas Fed President Logan explicitly opposed a December rate cut.
BofA believes that forcibly implementing a "hawkish rate cut" (i.e., cutting rates this time but strongly hinting at a pause next time) could backfire, and that waiting for more employment and inflation data to come out makes a December "dovish pause" a better choice.
Conflicting Data Deepens Committee Divides
September’s employment data failed to resolve controversy and instead added fuel to the fire. The BofA report points out that the unemployment rate is approaching 4.5%, a clear sign of a loosening labor market; but on the other hand, job gains, income growth, and labor participation are all performing strongly. These contradictions allow both the hawks and doves on the committee to stick to their arguments.
This division was fully revealed in statements from officials after the meeting. Although the market picked up dovish signals from Williams and Waller’s speeches, they are far from representative of consensus. Other FOMC members are not interested in rate cuts.
After the jobs report, Barr said the Fed needs to "act cautiously," Goolsbee focused on the risks of rising inflation, Logan explicitly opposed a December rate cut, and even the dovish Bowsher expressed a cautious attitude.
A "Dovish Pause" May Be the Better Choice
Facing what may be one of the most controversial decisions in recent years, BofA believes that for Powell, choosing a "dovish pause" is easier to carry out than pushing for a "hawkish rate cut." The former means doing nothing in December, but strongly hinting at the possibility of future rate cuts, thus preserving maximum flexibility for action in January next year.
BofA’s report states:
Powell can point out that between the December and January meetings we will receive a significant amount of data—three jobs reports, two unemployment rate readings, and two CPI reports—and if needed, the Fed is always ready to cut rates again in January.
By contrast, forcibly pushing for a "hawkish rate cut" (i.e., cutting rates this time but strongly implying a pause next time) may backfire. BofA doubts whether the market would believe this commitment, because if the hawks cannot obtain a reliable guarantee of a pause in January, they will be unwilling to compromise in December. In the end, even if Powell can secure enough votes, he might face a situation where nearly half of the regional Fed presidents explicitly or implicitly oppose.
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