Will it be “current” issued by the Fed? Or will this key word remain in guiding central bank policy?
On such a seemingly trivial question, the course of interest rates may hang when the Federal Open Market Committee announces the results of its two-day meeting next Wednesday afternoon.
Sure enough, the Fed’s Policy Setting Committee will raise the target range for the fed funds to 4.50%-4.75%. That would mark a downward turn to a 25 basis point increase, the FOMC’s usual rate move until last year, when it was playing catch-up on its monetary policy normalization, which was previously too easy. The committee mandated four significant hikes of 75 basis points in 2022, then added a 50 basis point increase in December. (A basis point is 1/100th of a percentage point).
At the time, the FOMC stated that it “expects that continued increases in the target range will be appropriate.” Retaining the plural “increases” in its policy statement implied an increase of at least 25 basis points, likely on March 21-22 and May 2-3. That would boost the target range for federal funds to 5%-5.25%, matching the average one-point forecast of 5.1% in the latest FOMC report. Summary of economic forecastsreleased at the December meeting.
But the market does not believe this. As the chart here shows, the federal funds futures market is pricing in only one increase at the March meeting. Having fixed the price target at 4.75%-5%, the market is currently expecting a 25bp cut the day after Halloween, returning to 4.50%-4.75%. That would put the key policy rate about half a point below the FOMC’s year-end average forecast, and below 17 of the 19 committee members’ forecasts.
The Treasury market is also fighting the Fed. The two-year note, which is most sensitive to price expectations, traded Friday at a yield of 4.215%, below the lower end of the current 4.25%-4.50% target range. The peak of the six-month Treasury yield curve is when T-bills are trading at 4.823%. From there, the curve slopes downward, with the 10-year benchmark note at 3.523%. Such a formation is a classic signal that the market is seeing lower interest rates in the future.
A slew of Fed speakers in recent weeks have spoken positively about changing the pace of rate hikes, pointing to a 25 basis point hike on Wednesday. But they all remained aware that monetary policy would continue on course to bring inflation back to the central bank’s 2% target.
Based on the latest reading of the central bank’s preferred measure of inflation, the personal consumption expenditures deflator, it’s too early to say that policy is constrained enough to reach that goal, argue John Riding and Conrad D. Quadros, veteran Fed watchers at Brian Capital. Data released on Friday showed the personal consumption expenditures (PCE) deflator rose 5.0% year on year. Therefore, even after a possible Fed funds hike this coming week, to a target range of 4.50%-4.75%, the key rate will remain negative when adjusted for inflation, indicating that Fed policy remains easy.
Economists at Brean Capital expect Federal Reserve Chairman Jerome Powell to repeat that the central bank will not repeat the mistake of the 1970s when it eased policy too quickly, allowing inflation to accelerate again. Recent measures of inflation have fallen below four-decade highs last year, largely due to lower prices for energy and commodities including used cars, which soared during the pandemic.
But Powell stressed the prices of essential non-residential services as leading indicators of future price trends. The rise in prices for non-residential services is seen to be mainly driven by labor costs. Powell stressed the tight labor market, which is reflected in a historically low unemployment rate of 3.5% and new unemployment insurance claims of less than 200,000.
But in what BCA Research calls a landmark speech, Fed Vice Chair Lyle Brainard noted that these non-residential service costs have risen more sharply than labor expenditures, according to the Employment Cost Index.
If so, one could infer that these inflation measures may cushion faster than the ECI, perhaps as a result of narrowing profit margins. Whatever the case, Reading in the fourth quarter ECI It will be released on Monday, the day before the FOMC meeting.
The Washington Post reported last week that Brainard, who has stressed the difference between the Fed’s actions and their impact on the economy, would be on a shortlist to replace Brian Daisy as chair of the National Economic Council. If she leaves for the White House, it will remove the main voice in favor of adjusting the pace of monetary policy tightening.
At the same time, while the federal funds rate approached restrictive levels, General financial conditions were declining. This is reflected in lower long-term borrowing costs, such as mortgage rates. corporate credit, especially in the high-yield market, which has rebounded in recent weeks; stock prices, up smartly from their October lows; volatility that has fallen sharply in stocks and fixed-income securities; A slide in the dollar, a great boon for exports.
In any case, if the FOMC statement talks about “continued” rate hikes, it would be a clue to the central bank’s thinking about future rates. Alternatively, the statement can assert that policy will become data-driven.
If so, economic data, such as the jobs report due on Friday morning and subsequent inflation readings, will import even further. A further slowdown in nonfarm payroll growth, to 185,000 in January from 223,000 in December, is a consensus call by economists. The December Employment Opportunities and Employment Turnover Survey, or JOLTS, arrives Wednesday morning, just in time for the FOMC to think.
The press conference after the meeting held by Powell will also send important signals. It will certainly be asked if business conditions are still tight after a spree of job cuts by tech companies. He will almost certainly be questioned about the wide gap between what the market sees in terms of rates and what is projected in the Fed’s December Summary of Economic Outlook, which will not be updated until March.
All that is certain is that the monetary policy debate will continue.
write to Randall W. Forsyth at [email protected]