Will it be “ongoing” outgoing at the Federal Reserve? Or will that keyword remain in the central bank’s policy directive?
The course of interest rates may depend on such a seemingly trivial question when the Federal Open Market Committee announces the results of its two-day meeting next Wednesday afternoon.
The Fed’s policy-setting panel will almost certainly raise its target range for fed funds to 4.50%-4.75%. That would represent a shift down to a 25 basis point hike, the FOMC’s usual rate move until last year, when it was trying to catch up on its previously super-easy monetary policy normalization. The committee imposed four giant 75 basis point increases in 2022 and then added a 50 basis point increase in December. (A basis point is 1/100 of a percentage point.)
At the time, the FOMC stated that it “anticipates that continued increases in the target range will be appropriate.” Retaining the plural word “increases” in his policy statement would imply at least two more 25 basis point increases, most likely in the March 21-22 and May 2-3 talks. That would push the target range for fed funds to 5%-5.25%, matching the average single point forecast of 5.1% in the most recent FOMC report. Summary of Economic Projectionsposted at the December meeting.
But the market does not believe it. As the chart here shows, the fed funds futures market is pricing in just one more rise at the March meeting. And after keeping its target rate at 4.75%-5%, the market currently anticipates a 25 basis point cut the day after Halloween, back to 4.50%-4.75%. That would put the key policy rate about half a point below the FOMC’s median year-end projection, and below 17 of the 19 committee members’ forecasts.
The Treasury market is also battling the Fed. The two-year note, the most sensitive maturity to rate expectations, traded on Friday for a yield of 4.215%, below the lower end of the current target range of 4, 25%-4.50%. The peak of the Treasury yield curve is six months, where Treasury bills are trading at 4.823%. From there, the curve slopes downward, with the benchmark 10-year note at 3.523%. Such a setup is a classic sign that the market anticipates lower interest rates in the future.
A series of Fed speakers in recent weeks have come out in favor of slowing rate hikes, pointing to a 25 basis point hike on Wednesday. But all have kept the message that monetary policy will stay the course to bring inflation back to the central bank’s 2% target.
Based on the latest reading of the central bank’s favorite measure of inflation, the personal consumption spending deflator, it’s too early to say the policy is tight enough to hit that target, argue John Ryding and Conrad DeQuadros, longtime policy watchers. the Fed at Brean Capital. Data released on Friday showed that the PCE deflator rose 5.0%, year-over-year. Thus, even after the likely increase in fed funds next week, to a target range of 4.50-4.75%, the key rate would still be negative when adjusted for inflation, indicating that policy from the Federal Reserve is still easy.
Brown Capital economists expect Fed Chairman Jerome Powell to reiterate that the central bank will not repeat the mistake of the 1970s when it eased policy too quickly, allowing inflation to reaccelerate. Recent inflation gauges have slipped below four-decade highs hit last year, largely due to declining prices for energy and goods, including used cars, which have skyrocketed during the pandemic.
But Powell has emphasized the prices of basic non-housing services as key indicators of future price trends. The increase in the prices of non-housing services is considered to be mainly due to labor costs. Powell has emphasized the tightness of the labor market, which is reflected in a historically low unemployment rate of 3.5% and new claims for unemployment insurance below 200,000.
But in what BCA Research calls a major speech, Fed Vice Chair Lael Brainard noted that these non-housing service costs have risen more than labor expenses, as measured by the employment cost index.
If so, it could be inferred that these measures of inflation could decline faster than the ECI, perhaps as a result of reduced profit margins. In any case a fourth quarter ECI reading it will be released on Monday, the day before the members of the Federal Open Market Committee meet.
The Washington Post reported last week that Brainard, who has emphasized the lag between Fed actions and their impact on the economy, was on a short list to replace Brian Deese as head of the National Economic Council. If he goes to the White House, that would remove a key voice in favor of easing the pace of monetary policy tightening.
At the same time, while the federal funds rate has approached restrictive levels, general financial conditions have been easing. That’s reflected in the declining costs of long-term borrowing, such as mortgage rates; corporate credit, especially in the high-yield market, which has picked up in recent weeks; stock prices well above their October lows; volatility, which has receded considerably for stocks and fixed income securities; and the fall of the dollar, a great boost for exports.
In any case, if the FOMC statement talks about “ongoing” rate hikes, that will serve as a clue to central bank thinking on future rates. alternatively, the statement could emphasize that policy will become data dependent.
If so, economic releases such as the jobs report to be released on Friday morning and subsequent inflation readings will become even more important. A further slowdown in nonfarm payroll growth, to 185,000 in January from 223,000 in December is the consensus call from economists. The release of the December Job Vacancy and Job Turnover Survey, or JOLTS, comes Wednesday morning, in time for the FOMC to mull it over.
Powell’s post-meeting press conference will also send important signals. You will be asked if working conditions are still strict after the wave of job cuts by tech companies. And you’ll likely be asked about the wide gap between what the market sees for rates and what’s predicted in the Fed’s December Summary Economic Projections, which won’t be updated until March.
All that is certain is that the monetary policy debate will continue.
write to Randall W. Forsyth in firstname.lastname@example.org
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