The Federal Reserve kept rates steady on Wednesday as the central bank continued its cautious monetary policy approach, though stopped short of ruling out further rate hikes. The decision came amid a backdrop of a growing economy, strong labour market, and inflation that is still well above the central bank’s target.

As widely expected, the Fed’s rate-setting committee unanimously agreed to hold the key federal funds rate in a target range between 5.25%-5.5%. This was the second consecutive meeting that the Federal Open Market Committee chose to hold, following a string of 11 interest rate hikes since March 2023.

Source: Federal Reserve Bank of New York

While Fed Chair Jerome Powell left the door open for another rate hike, he used a less hawkish tone than markets were anticipating, acknowledging that monetary conditions had tightened substantially in recent months, which raised hopes that the Fed isn’t likely to resume rate hikes.

Yet, the pick-up in economic activity remains a worry for the Fed as it threatens to boost inflation, clouding the Fed’s progress toward bringing down inflation. The U.S. economy accelerated to 4.9% in Q3, according to data released last week, marking the biggest rise in growth in nearly two years. The solid growth was underpinned by a still-strong labour market which has been supporting consumer spending. However, such a solid growth rate might not be sustainable moving forward.

The major question facing Fed officials is whether they will need to make one final rate increase in December, a possibility they left open on Wednesday. However, traders have taken Jerome Powell comments as a sign that the Fed is likely done with its rate hikes and now expect rate cuts by mid-2024.

Treasury yields retreated, after having previously climbed to levels last seen in 2007, while equity markets rebounded strongly. Although yields declined from their recent highs it is unlikely that they will return to pre-pandemic lows any time soon. For consumers, elevated yields mean financial pain, because itserves as a benchmark rate for a variety of consumer borrowings.

Over the past few months, inflation has been stabilizing, with annual consumer price growth falling to 3.7% from the 9.1% high reached last year, but the labour market has remained stubbornly resilient. The October ADP private sector payrolls came in at a lower than the expected 113,000 but is still stronger than the September reading.

The ADP data came ahead of Friday’s nonfarm payroll report, which will give the Fed a new detailed reading on the state of the still-tight labour market. Until the labour market has cooled substantially and inflation rates drop back to the Fed’s 2% target, the option of future rate hikes remains on the table.

Source: TradingView

Continuing war between Russia and Ukraine, growing tensions in the Middle East, as well as souring U.S. and China relations are spurring fear among investors. Although immediate worries from the Middle East conflict appear to have subsided, investors remain on edge. Prolonged war could drive oil prices and inflation higher, which in turn would hurt economic growth.

While the strongly oversold U.S. equity index has rallied over the past four days, upside from here is likely to be limited and new fresh highs are unlikely. The economic impact from the Fed tightening is yet to materialise and, in our view, high borrowing costs could take down consumer spending or the job market soon. Therefore, while November and December could be favourable for the stock market, the current strength is unlikely to extend into next year.