By Lewis Krauskopf and Davide Barbuscia
NEW YORK (Reuters) -Investors were pinning hopes on more monetary policy easing ahead, even as Wednesday's Federal Reserve meeting revealed a less-certain path toward more interest rate cuts in the face of a data drought, sticky inflation and divided opinions among the central bank's members.
Fed Chair Jerome Powell surprised markets by casting doubt on the prospects of an interest rate cut at the central bank's next meeting in December, saying such a move was
"not a foregone conclusion" even though markets had priced it as an almost-done deal. Wall Street erased gains and bonds were sold off after he spoke.
His remarks came at a press conference after the Fed announced its decision to lower rates by a quarter percentage point and halt its balance sheet drawdown - market-friendly measures that were nonetheless already expected and baked into asset prices.
LACK OF DATA CLOUDING DECISION-MAKING
The U.S. government shutdown means that labor market and other economic data the Fed has traditionally relied upon to make decisions are not available, clouding policymakers' decision-making and breeding more uncertainty for investors.
The lack of data "is going to make it very hard to forecast where we think the Fed is going to be in six weeks' time,” said John Velis, Americas macro strategist at BNY.
Between now and the December 9-10 meeting, there could be some "not immaterial swings in the probabilities in the expectation of a cut or not a cut in December," he said. "And I think that could create a bit of volatility."
A weakening jobs picture had prompted the Fed to cut rates in September for the first time in 2025, while the latest data suggests inflation remains above the Fed's 2% target.
Wednesday's decision drew dissents from Fed Governor Stephen Miran, who again called for a deeper reduction in borrowing costs, and from Kansas City Fed President Jeffrey Schmid, who favored no cut at all given ongoing inflation.
With the Fed's lowering of the policy rate to a range of 3.75% to 4%, rates are 150 basis points below their peak last year.
INVESTORS HOLDING OUT HOPES FOR DECEMBER CUT
The chair's injection of uncertainty around a December cut could cast more doubt on next year, said Jim Caron, chief investment officer of the portfolio solutions group at Morgan Stanley Investment Management.
"The markets hear that, and they go, well, wait a minute … if we're debating whether they go one more time right now, well then how sure can you be that we're going to go to 3% in 2026?" Caron said.
He added, however, that a slowdown in the labor market will likely justify a December cut. "I don't think it changes the big picture trajectory of what's going on," he said.
Investors appeared to be holding on to hopes the central bank would ease at its next policy meeting. U.S. rate futures pricing on Wednesday showed a 67.9% chance of another 25 basis points cut in December, according to LSEG calculations, down from an 85% probability prior to Powell's comments.
Traders still saw rates eventually ending at around 3% at the end of next year, unchanged from prior to the meeting.
Michael Arone, chief investment strategist at State Street Investment Management, said he still expected the Fed to ease in December.
"You will eventually get some data and what I expect is that it will show a continued weakening in the labor market," Arone said.
But some saw cause for greater skepticism.
"We see this meeting as far more hawkish than market pricing," Bespoke Investment Group said in a note, adding the repeated emphasis Powell put on a heated debate at the Fed "justifies an even bigger re-rating of December cut odds."
STOCKS HAD RALLIED AHEAD OF FED DECISION
Stocks swung following Powell's comments, with the S&P 500 index ending flat on the day, giving up the modest gain it held during Wednesday's trading prior to the Fed's decision. Treasury yields moved higher, with the benchmark 10-year yield last around 4.06%, while the dollar strengthened against a basket of major currencies.
Expectations for more easing have been helping stocks rally and the S&P 500 had gained for four straight days heading into Wednesday. "Stocks look richer now than they did yesterday based on what just happened," said Matt Rowe, senior portfolio manager at Man Group.
Meanwhile, some market participants downplayed the impact on risk assets coming from the end of the central bank’s balance sheet drawdown, which the Fed said on Wednesday will stop in December.
After swelling its balance sheet during the COVID-19 pandemic, buying Treasury bonds and mortgage-backed securities to keep the economy afloat, the Fed has spent the past three years putting its portfolio on a diet. From a peak of near $9 trillion in 2022, the Fed’s holdings have slimmed to about $6.6 trillion.
The runoff, known as quantitative tightening (QT), has come mostly from letting securities mature and roll off its books, with the heavy lifting made through reductions in government bond holdings.
Amar Reganti, fixed-income strategist at Hartford Funds, said the end of QT would be only marginally positive for broader markets, partly because the balance sheet runoff was happening very gradually.
Had the Fed been more dovish with its rate outlook, combined with the QT messaging, that "could have certainly permeated a much stronger risk-on sentiment," Reganti said.
"But that wasn't the case."
(Reporting by Lewis Krauskopf and Davide Barbuscia; Editing by Alden Bentley and Jamie Freed)
