Will the Federal Reserve “continue” to withdraw? Or will that key word remain in the central bank’s policy directive?
When the Federal Open Market Committee announces the results of its two-day meeting this coming Wednesday afternoon, such a trivial question could put the course of interest rates on hold.
The central bank’s policy-making committee is set to raise its federal-funds target range to 4.50%-4.75%. That would mark a drop from the 25-basis-point increase, the FOMC’s usual rate move until last year, when it played catch-up in normalizing its monetary policy, which had previously been uber-easy. The committee imposed four supersize 75-basis-point hikes 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 said it “expects the current increase in the target range to be appropriate.” Retaining the plural term “hikes” in its policy statement would mean at least two 25-basis point hikes, most likely at the March 21-22 and May 2-3 confabs. That would match the FOMC’s most recent median 5.1% single-point forecast and raise the Fed-funds target range to 5%-5.25%. Summary of Economic ForecastsPublished at the December meeting.
But the market does not believe this. As the chart here shows, the Fed-Funds futures market is pricing in just one more upside at the March meeting. After keeping its rate target at 4.75%-5%, the market now expects a 25-basis-point cut the day after Halloween, again to 4.50%-4.75%. That would put the key policy rate half-a-point below the FOMC’s median year-end forecast, and below 17 of the 19 panel members’ forecasts.
The Treasury market is also struggling with the central bank. The two-year note, the most sensitive maturity to rate expectations, traded at a yield of 4.215% on Friday, below the current 4.25%-4.50% target range. The apex of the Treasury yield curve is at six months, where T-bills are trading at 4.823%. From there, the curve slopes downward, with the benchmark 10-year benchmark at 3.523%. Such a structure is a classic signal that the market is seeing low interest rates.
A string of Fed speakers in recent weeks have spoken in favor of slowing the pace of rate hikes, pointing to a 25-basis-point hike on Wednesday. But they all hinge on news that monetary policy will continue to push inflation back to the central bank’s target of 2%.
Based on the latest reading of the central bank’s preferred inflation measure, personal consumption expenditure inflation, it is too early to say that policy has been restrained enough to achieve that goal, argue John Riding and Conrad DiQuadros, senior Fed watchers at Brean Capital. Data released on Friday showed the PCE deflator rose 5.0% year-on-year. Therefore, the key rate will remain negative when adjusted for inflation, even after the Fed-funds hike, to a target range of 4.50%-4.75% this week, indicating an easing of central bank policy.
Brent Capital economists expect Fed Chairman Jerome Powell to reiterate that the Fed will not repeat the mistake of the 1970s when it eased 1970s policy too quickly and allowed inflation to accelerate again. The latest inflation readings have fallen below the four-decade peak they hit last year, largely driven by reduced prices of goods, including energy and used cars, which soared during the pandemic.
But Powell emphasized non-housing core service prices as key indicators of future price trends. Inflation in non-housing services is mainly driven by labor costs. Powell emphasized the tightening of the jobs market, reflected in a historically low unemployment rate of 3.5% and new claims for unemployment insurance running below 200,000.
But in a keynote speech by BCA Research, Fed Vice Chairman Lael Brainard noted that these non-housing service costs have risen more sharply than labor costs.
If so, one might hypothesize that these measures of inflation may decline faster than the ECI, perhaps as a result of lower profit margins. In any case, A reading on the fourth quarter ECI The announcement will be made Monday, a day before members of the Federal Open Market Committee meet.
The Washington Post reported last week that Brainard, who emphasized the disconnect between Fed actions and their impact on the economy, was on the short list to replace Brian Deiss as chairman of the National Economic Council. If he moves to the White House, it will remove a key voice in favor of moderating the pace of monetary policy tightening.
At the same time, the Fed-funds rate has moved closer to controlled levels, Overall financial conditions have eased. This is reflected in the decline in long-term borrowing costs such as mortgage rates; Corporate debt, particularly in the high-yield market, has rallied in recent weeks; Stock prices rallied smartly from October lows; Volatility, which pulled back hard for equities and fixed income bonds; And the dollar’s decline is a big boon for exports.
However, if the FOMC’s report talks about “on-going” rate hikes, that could provide a clue to the Fed’s thinking about future rates. Alternatively, the report may emphasize that policy will become data-driven.
If so, economic releases such as Friday morning’s upcoming jobs report and subsequent inflation readings will take on even more import. The consensus call among economists is for a further decline in nonfarm payrolls growth to 185,000 in January from 223,000 in December. The release of the December jobs 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 was asked if labor conditions were tighter after the tech giants cut jobs. He will be quizzed about the widening gap between what the market sees for rates and what was predicted in the central bank’s December brief economic projections, which won’t be updated until March.
What is certain is that the debate over monetary policy will continue.
Write to Randall W. Forsyth at [email protected]