Will the Federal Reserve “continue” outflows? Or will the central bank’s policy be the same word?
Such a seemingly trivial question could hang the course of interest rates when the Federal Open Market Committee announces the results of its two-day meeting this coming Wednesday afternoon.
The Fed’s policy-making panel is confident of raising its federal-funds target to 4.50%-4.75%. That would represent a downshift to a 25-basis-point hike, the usual rate the FOMC has moved until last year, when it was playing catch-up in normalizing its monetary policy, which had previously been uber-easy. The committee imposed four supersize 75-basis-point hikes in 2022 and then added a 50-basis-point hike in December. (A basis point is 1/100th of a percentage point.)
At the time, the FOMC said it “expects that ongoing increases in the target range will be appropriate.” Retaining the plural word “increase” in his policy statement would mean at least two more 25-basis-point hikes, likely at the March 21-22 and May 2-3 confabs. That would raise the fed-funds target range to 5%-5.25%, matching the FOMC’s most recent single-point forecast of 5.1%. Summary of Economic AssumptionsReleased at the December meeting.
But the market doesn’t believe it. As the chart here shows, the Fed-Funds futures market is pricing in just one hike at the March meeting. And after keeping the rate target at 4.75%-5%, the market currently expects a 25-basis-point cut back to 4.50%-4.75% the day after Halloween. That would put the key policy rate about a half-point below the FOMC’s mid-year end projection and below 17 of 19 committee members’ forecasts.
Treasury markets are also struggling with the Fed. Two-year notes, the most sensitive to maturity rate expectations, traded on Friday at a yield of 4.215%, below the lower end of the current 4.25%-4.50% target range. The Treasury yield curve is at a six-month high, with T-bills trading at 4.823%. From there, the curve slopes lower, with the benchmark 10-year note at 3.523%. Such a configuration is a classic signal that the market sees low interest rates ahead.
An array of Fed speakers in recent weeks has spoken favorably of slowing rate hikes, pointing to a 25-basis-point hike on Wednesday. But they all remained on the message that monetary policy would continue to push inflation back to the central bank’s target of 2%.
Based on the latest readings of the central bank’s preferred measure of inflation, the private consumption expenditure deflator, it is too early to say policy is tight enough to reach this goal, argue veteran Fed watchers John Riding and Conrad DiQuadros of Brain Capital. Data released on Friday showed the PCE deflator rose 5.0% year-over-year. So, even after a possible Fed-funds hike this coming week, the key rate will still be negative when adjusted for inflation, in the 4.50%-4.75% target range, indicating that Fed policy remains easy.
Brain 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 re-accelerate. Recent inflation gauges have fallen below four-decade highs hit last year, largely due to lower prices for energy and goods, including used cars, which had risen during the pandemic.
But Powell emphasized the price of non-housing core services as a key indicator of future price trends. The price increase in non-housing services appears to be mainly driven by labor costs. Powell emphasized the strength of the job market, reflected in a historically low unemployment rate of 3.5% and new claims for unemployment insurance running below 200,000.
But in what BCA Research called an important speech, Fed Vice Chair Lell Brainard noted that these non-housing services costs rose more sharply than labor costs, as measured by the Employment Cost Index.
If so, one might speculate that these inflationary measures may ease faster than the ECI, perhaps as a result of narrowing profit margins. In any case, A reading on ECI for the fourth quarter will be released on Monday, a day before members of the Federal Open Market Committee convene.
Brainard, who has emphasized the gap between the Fed’s actions and their impact on the economy, was reported by the Washington Post last week to be on a short list to replace Brian Diez as head of the National Economic Council. If he leaves for the White House, it will remove a key voice in favor of controlling the pace of monetary policy tightening.
At the same time, when the fed-funds rate moved closer to the threshold level, Overall financial conditions have eased. This is reflected in lower long-term borrowing costs, such as mortgage rates; corporate credit, particularly in the high-yield market, which has risen in recent weeks; Stock prices, rising smartly from their October lows; Volatility, which has declined sharply for equity and fixed-income securities; And the dollar slide, a big boon for exports.
In any case, if the FOMC’s statement refers to an “ongoing” rate hike, it will serve as a clue to the central bank’s thinking about future rates. Alternatively, the statement may emphasize that the policy will become data-dependent.
If so, economic releases, such as the jobs report due Friday morning and subsequent inflation readings, will have more import. A consensus of economists called for a further decline in nonfarm payrolls growth, to 185,000 in January from 223,000 in December. The release of the December Job Openings and Labor Turnover Survey, or JOLTS, comes Wednesday morning, just in time for the FOMC to ponder.
Powell’s post-meeting press conference will also send important signals. He will be asked if labor conditions are tight after a flurry of job cuts by tech firms. And he is sure to be asked about the widening gulf between what the market is looking for in rates and what is predicted in the Fed’s summary of December economic projections, which won’t be updated until March.
It is only certain that the debate over monetary policy will continue.
write down At Randall W. Forsyth firstname.lastname@example.org
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