Economists are taking a second look at Federal Reserve Chairman Jerome Powell's speech Wednesday and wondering if the sharply dovish reaction wasn't a bit overdone.
The central bank chief's proclamation that interest rates are "just below" what would be considered a "neutral" level represents a definite change in verbiage from his October "a long way from neutral" assessment. But as a practical matter, these Fed watchers say, the chairman was only saying that the current rate is near the "range" of estimates from the Fed's individual policymakers. That range is between 2.5 percent and 3.5 percent.
The distinction could be critical for where the Fed is headed.
"If there has been one certainty of late it is the market's ability to misinterpret Fed Chairman Powell," Tom Porcelli, chief U.S. economist at RBC Capital Markets, said in a note. "The market viewed this as a dovish development. We think this is the wrong interpretation. Powell is not suggesting that since they are just below the range they may stop soon. All he is doing is pointing out an obvious idea."
Nevertheless, Powell's comments at The Economic Club of New York sparked a powerful market rally. The Dow Jones Industrial Average roared to a 618-point gain, helping to alleviate much of the pain the market has experienced since the chairman's October comments.
But there didn't look to be follow-through Thursday. Major indexes were lower Thursday as Wall Street digested both what Powell had to say and the challenges ahead.
In addition to the stock market gain, markets also lowered their expectations for future rate hikes, which already had been below Fed forecasts of another move in December and three more in 2019. Fed fund futures trading now indicates a quarter-point increase next month, then only a 29 percent chance of two hikes in 2019, according to CME calculations.
Porcelli thinks that's the incorrect view, pointing out that in past rate-hiking cycles the funds rate has ended up 100 basis points, or a full percentage point, above the neutral estimate.
"We will say it again, despite the broad narrative that the Fed has gotten spooked by the equity market volatility (something Powell again refuted in his speech today), the most likely trajectory for Fed policy has not changed," he said. "The market, by pricing in just about 1 hike next year has implicitly a much weaker economic narrative baked in. We continue to see the risks around economic growth skewed to the upside based on trends borne out in the data."
Indeed, some of the more hawkish economists on the Street stuck to their forecasts.
Jan Hatzius, chief economist at Goldman Sachs, still thinks the Fed will hike four times in 2019, which is above the current indications from the Federal Open Market Committee's closely watched "dot-plot" estimates. The FOMC sets interest rates for the Fed, and the dots represent where each member sees rates.
Where the market saw a major shift from Powell, Hatzius saw only nuance. He characterized the Powell speech as "in line with prior remarks."
The chairman highlighted "both the significant uncertainty around neutral rate estimates and the fact that current rates remain below the lowest of the Fed's model estimates of neutral. He reiterated a gradual path — interpreted in our view to mean quarterly rate hikes — as the middle ground between the risks of hiking too quickly and too slowly," Hatzius wrote.
Similarly, J.P. Morgan also still sees four hikes ahead. Michael Feroli, the firm's chief U.S. economist, said the market may have read a little too much in the difference between Powell's October and November remarks.
"The shift in emphasis is clear" between the two comments, Feroli wrote. "The literal differences between the two sets of comments are less stark."
In fact, Feroli figures Powell basically said the same thing both times — the Fed remains "a long way" from the consensus neutral rate of about 3 percent, and is "just below" the range of estimates that span 100 basis points.
Ultimately, the Fed will be moved most by forward economic developments such as the government's monthly nonfarm payrolls report, which Feroli expects to be strong.
"With respect to the neutral rate we didn't find too much at odds with previous Committee communications," he wrote of Wednesday's Powell speech. Of market reaction, he cautioned that "financial market jubilation at the prospect of a pause could eventually plant the seeds of its own undoing."
Bank of America Merrill Lynch economists also think the market took an overly dovish view of the speech.
They point to comments that indicated the Fed isn't sure where neutral is, and that there is a lag between rate hikes and their impact.
"We believe he shifted from his comments in the fall by underscoring data dependency and the lags in the monetary policy while walking away from the need to move into restrictive territory," Ethan Harris, global economist at BofAML, said in a note. "The speech read more dovish than his prior remarks but was not, in our view, a dovish speech."