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The US Federal Reserve left key interest rates unchanged, as expected. What came as a surprise, however, was the message behind the decision: the Federal Reserve made it clear that a rate hike is by no means off the table. For many investors, this clarification came too late. “Markets were positioned too dovishly,” says Thorsten Fischer, Managing Director and Head of Portfolio Management at Moventum AM. “It was not the Fed that surprised, but rather the expectations of many market participants.”

The starting point was clear. The US economy continues to grow, the labour market remains stable, and inflation is still above the two per cent target. Under these conditions, there was little reason to ease the monetary policy stance. Nevertheless, many investors had hoped for signals pointing to an imminent rate cut. “Those hopes were disappointed,” says Fischer. “The central bank’s projections show that many members of the Federal Open Market Committee now consider at least one rate hike this year to be necessary.” New Fed Chair Kevin Warsh also made it clear that fighting inflation is his top priority.

His message — “We have missed the target for five years, and we are going to change that” — marks a new direction. The statement is aimed less at the next meeting than at the role of the central bank as a whole. “Warsh is not only talking about the next interest rate move, but about reshaping the Fed itself,” says Fischer. “This marks the beginning of an institutional regime change.” At his first meeting, Warsh set clear accents: the monetary policy statement was shorter, the usual dot plot projection was omitted, and the previously extensive forward guidance was scaled back.

In doing so, the Fed is moving away from a communication style that had provided markets with a pre-defined interest rate path for years. “Warsh wants to retain greater room for manoeuvre and is putting price stability back at the centre,” says Fischer. “In future, the Fed intends to align itself more closely with its mandate and less with the short-term management of market expectations.”

Particularly noteworthy is the announcement of five working groups that are to review key areas of the central bank. Among other things, they will analyse the data sources used, communication policy, balance sheet management and the monetary policy framework. “Warsh is not announcing a revolution, but a restructuring,” says Fischer. “He is putting the way the Fed operates to the test and is deliberately giving himself time to do so.” The results of these working groups are not expected until the end of the year. This underlines the long-term nature of the undertaking.

Financial markets, by contrast, reacted much more quickly. There were sharp movements, particularly at the short end of the yield curve. The yield on two-year US Treasury bonds temporarily rose by around 16 basis points. For a single trading day, this is an exceptional move. “However, this development is less an expression of a surprising Fed and more the result of overly optimistic positioning by many investors,” says Fischer. “The expectation of a rapid easing of monetary policy had become deeply embedded in the markets.” Following the meeting, those expectations had to be corrected.

The political dimension is also interesting. While Donald Trump regularly criticised his predecessor Jerome Powell, even when rates were cut, the White House reacted differently this time. Trump allowed Warsh to proceed despite unchanged interest rates and is supporting him. “This gives Warsh a political starting advantage that Powell never had,” says Fischer. “As a result, the short-term risk of an open conflict between the government and the central bank has declined.”

For investors, this leads to an important insight: the phase in which every pause in interest rates was automatically interpreted as a precursor to easing is likely to be over for the time being. “Markets must learn to pay closer attention to the reality of inflation again and less to the hope of swift monetary policy support,” says Fischer. “The Fed is sending a clear signal: a pause in rates is not a rate cut waiting to happen.”