Will “ongoing” run out at the Federal Reserve? Or will this keyword remain in the central bank’s policy?
Interest rates could be hanging 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 monetary policy committee is all but certain to raise the target range for federal funds to 4.50%-4.75%. That would mean a downgrade to a 25 basis point hike, the FOMC’s usual rate move until last year when it caught up on policy normalization, which was previously very easy. The committee imposed four outsized 75 basis point hikes in 2022, then added a 50 basis point hike in December. (A basis point is 1/100 percentage point.)
At the time, the FOMC stated that it “expects that continued increases in the target range will be appropriate.” Keeping the plural word “raises” in their policy statement would imply at least two more 25 basis point raises, most likely at the March 21-22 and May 2-3 confabs. That would raise the Fed funds’ target range to 5%-5.25%, in line with the average single-point forecast of 5.1% in the most recent FOMC forecast Summary of economic forecastsreleased at the December meeting.
But the market doesn’t think so. As the chart here shows, the fed funds futures market is pricing in just one more hike at the March meeting. And after keeping its rate target at 4.75% to 5%, the market is currently expecting a 25 basis point cut the day after Halloween, back to 4.50% to 4.75%. That would put the policy rate about half a point below the FOMC’s year-end median forecast and below 17 of the 19 committee members’ forecasts.
The Treasury market is also fighting against the Fed. The two-year note, the maturity most sensitive to interest rate expectations, traded at a yield of 4.215% on Friday, below the lower end of the current 4.25% to 4.50% target range. The Treasury yield curve peaks at six months, where T-Bills trade at 4.823%. From there, the curve slopes down, with the 10-year benchmark grade sitting at 3.523%. Such a configuration is a classic signal that the market expects lower interest rates.
A number of Fed speakers in recent weeks have been supportive of a slowdown in the pace of rate hikes, pointing to a 25 basis point hike on Wednesday. But they have all stuck to the message that monetary policy will remain on course to bring inflation back towards the central bank’s 2% target.
Based on the latest readings of the central bank’s preferred measure of inflation, the personal consumption expenditure deflator, it’s too early to say the policy is tight enough to achieve that goal, argue John Ryding and Conrad DeQuadros, the veteran Feds – Observer at Brean Capital. Data released on Friday showed that the PCE deflator rose 5.0% year-on-year. Even after the Fed funds’ likely hike to a target range of 4.50%-4.75% next week, the policy rate would still be negative on an inflation-adjusted basis, suggesting that Fed policy remains loose.
Brean Capital economists expect Fed Chair Jerome Powell to reiterate that the central bank will not repeat the mistake of the 1970s, when it eased monetary policy too quickly and accelerated inflation again. Recent inflation indicators have slipped below four-decade highs reached last year, mainly due to falling prices for energy and goods, including used cars, which have soared during the pandemic.
But Powell has highlighted prices for core non-housing services as key indicators of future price trends. The increase in prices for non-housing services is mainly driven by labor costs. Powell has highlighted the tightening of the job market, reflected in a historically low unemployment rate of 3.5% and new jobless claims of under 200,000.
But in what BCA Research calls an important speech, Fed Vice Chair Lael Brainard noted that these incidental service costs, as measured by the Employment Cost Index, have risen more than labor costs.
If this is the case, one might conclude that these inflation gauges may be declining faster than the ECI, possibly as a result of declining profit margins. Definitely, a reading on the ECI of the fourth quarter will be released on Monday, one day before members of the Federal Open Market Committee meet.
Brainard, who has stressed the lag between the Fed’s actions and their impact on the economy, was reported by the Washington Post last week that he is shortlisted to replace Brian Deese as head of the National Economic Council. If she goes to the White House, it would lose an important vote for modest monetary tightening.
At the same time as the Fed Funds interest rate has approached restrictive levels, General financial conditions have eased. This is reflected in the decline in long-term borrowing costs such as mortgage interest; corporate bonds, particularly in the high yield market which has rallied in recent weeks; stock prices, which have risen significantly from their October lows; volatility, which has fallen sharply in equities and fixed income securities; and the fall of the dollar, a great boon to exports.
Certainly, when the FOMC statement mentions “ongoing” rate hikes, it will serve as an indication of how the central bank thinks about future interest rates. Alternatively, the statement could emphasize that policy is becoming data dependent.
If that is the case, economic releases such as the jobs report due Friday morning and subsequent inflation data will become even more important. A further slowdown in nonfarm payrolls growth from 223k in December to 185k in January is consensus economists are calling for. The December release of the Job Openings and Labor Turnover Survey (JOLTS) arrives Wednesday morning, in time for the FOMC to consider.
Powell’s post-meeting press conference will also send important signals. He will certainly be asked if working conditions remain tight following the downsizing at tech companies. And he’ll certainly be questioned about the wide gap between what the market sees for interest rates and the forecasts in the Fed’s December economic forecast summary, which won’t be updated until March.
The only thing that is certain is that the debate on monetary policy will continue.
write it Randall W. Forsyth email@example.com
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