In the past several days, the markets have become convinced Fed officials are intentionally signaling that they could pause from raising interest rates next year.
The recent speeches from several officials have been interpreted as being more dovish, even if the officials haven't strayed much from their core message — that the Fed is on a gradual rate hiking path, that the U.S. economy is in good shape, inflation is steady and the Fed remains dependent on economic data.
But the market also is interpreting a new tone in the words of these Fed officials, who seem to be more seriously looking beyond the strong U.S. economy to an environment where stock prices have been falling and credit spreads are widening.
Fed Chairman Jerome Powell, for instance, noted on Wednesday that there's been "a gradual chipping away" at global growth and what happens internationally matters. The same point was made Friday by Fed Vice Chair Richard Clarida, who told CNBC that the global economy deserves attention, and it looks like it's slowing.
"There's a bit of a walk back in progress," said Don Rissmiller, chief economist at Strategas Research. "I'm sure they're looking at financial conditions."
The market's interpretation of the recent comments is in sharp contract to the response to Powell's Oct. 3 comment that the Fed is still a long way from neutral. That comment was interpreted to mean the Fed was confidently moving forward with the rate hikes it has already forecast for 2019, and possibly adding more.
Now, the markets still expect the Fed to go through with a rate hike at its December meeting, but the three more hikes anticipated for next year are in doubt.
Jon Hill, U.S. rate strategist at BMO, said since Nov. 9, the fed funds futures market has reduced its expectations for rate hikes next year to just 1.4 hikes from 2.2.
""Clarida sounds a bit more dovish, but he didn't say anything remarkable," said Hill. "To price out almost an entire hike in a week just because [they] acknowledge overseas matters seems a bit too aggressive."
Hill said New York Fed President John Williams comments Monday that the Fed was raising rates "somewhat" also sounded a bit more dovish. Williams added that it's "really in the context of a very strong economy and obviously we're not on a preset course," according to a Bloomberg report.
Financial conditions are clearly worsening, with the S&P 500 down 9.5 percent since the end of September, and the spreads on corporate credit widening, meaning the market is pricing it at increasingly lower prices [and higher yields], relative to Treasurys. Prices move in the opposite direction of yields.
At the same time, investors are jumping into the safety of Treasurys, driving interest rates lower. The 10-year is now yielding 3.03 percent, the lowest since Oct. 3, the day Powell made his hawkish comments.
Rissmiller has been forecasting the Fed will only be able to raise interest rates twice next year, as some others also expect. He said the neutral rate, or the interest rate level where the Fed is no longer stimulating the economy or trying to slow it down, is probably closer to 2.5 percent. The Fed funds target range is currently at 2 percent to 2.25 percent.
"I just don't see the rush. Why snatch defeat from the jaws of victory. They are succeeding here. They can remain in a rate hike cycle," said Rissmiller.
But on the other extreme, Goldman Sachs economists expect the Fed to raise interest rates four times next year, and they note that inflation could jump more than expected.
George Goncalves, head of fixed income strategy at Nomura, said the fact that the Fed officals sound somewhat synchronized has convinced the market that they are intentionally sending a dovish message.
"The market is perceiving them as being more dovish...It's a small pivot because they're acknowledging the idea that when you get closer to the end of a hiking cycle you have to feel your way through. You want flexibility. It doesn't mean they have to stop soon," he said.
Goncalves said in addition to giving a nod to the global economy, both Powell and Clarida used an analogy about being in a dark room.
"I think Chair Powell the other day made the analogy in Dallas, you know, about if you're in a darkroom, especially without your shoes on, you want to go slow so you don't stub your toe. So I think data dependence makes sense right here," Clarida said in the CNBC interview.
Goncalves said Powell added that you could both speed up or slow down in the dark.
"In Powell's speech and Clarida emphasized it, if you're in a room and the lights go out, and it becomes dark, you'll slow down," he said. He said it's possible the Fed could slow down but it's not necessarily signaling that now. "It's definitely a risk we have to entertain but to move it into a central case is too soon."
Bespoke's index on Fed speak has fallen below zero, indicating a more dovish sounding Fed. According to George Pearkes, Bespoke macro strategist, the index measures the last 20 speeches of Fed officials. He rated the last Powell speech as neutral, though the market heard it as dovish.