Will there be “ongoing” outgoings in the Federal Reserve? Or will this keyword remain in the central bank’s policy directive?
When the Federal Open Market Committee announces the results of its two-day meeting next Wednesday afternoon, a seemingly trivial question could affect the course of interest rates.
The Fed’s policymaking panel is almost certain to raise the federal funds target range to 4.50% to 4.75%. This represents a drop towards a 25 basis point increase, which was the usual rate move until last year when the FOMC tried to catch up on normalizing monetary policy, which was so easy before. The committee applied four large 75 basis points hikes in 2022, followed by a 50 basis point increase in December. (The base score is 1/100th of the percentage score.)
At the time, the FOMC stated that it “anticipates continued increases in the target range to be appropriate.” Keeping the plural word “raise” in the policy statement would likely mean at least two more 25bp hikes, on March 21-22 and May 2-3 confabs. This would increase the federal funds target range to 5% – 5.25%, matching the median single-point estimate of 5.1% in the FOMC’s most recent estimate. Summary of Economic ForecastsIt was published at the meeting in December.
But the market doesn’t believe it. As the chart here shows, the federal funds futures market is pricing in just one more hike at its March meeting. After keeping the rate target at 4.75%-5%, the market is currently expecting a 25 basis point cut back to 4.50%-4.75% the day after Halloween. This places the base policy rate about half a point below the FOMC’s median year-end forecast and 17 percent below the 19 committee members’ forecasts.
The Treasury market is also fighting the Fed. The two-year bond, the most sensitive to interest rate expectations, traded below the lower end of the current 4.25%-4.50% target range, with a yield of 4.215% on Friday. The peak of the treasury yield curve is in the six months, when treasury bills were trading at 4,823%. From there, the curve slopes downward with the 10-year benchmark rating of 3.523%. Such a configuration is a classic signal that the market is seeing lower interest rates in the future.
A number of Fed speakers in recent weeks have spoken positively of the slowdown in rate hikes, pointing to a 25bp increase on Wednesday. But they all remained in the message that monetary policy will move towards bringing inflation back to the Central Bank’s 2% target.
Based on recent readings of the personal consumption expenditure deflator, the central bank’s preferred measure of inflation, Brean Capital’s senior Fed watchers John Ryding and Conrad DeQuadros say it’s too early to say that policy is restrictive enough to meet that target. Data released Friday showed that the PCE deflator rose 5.0% year-over-year. Therefore, even after a possible federal funds increase next week, the base rate will still be negative when adjusted for inflation, to the target range of 4.50%-4.75%, indicating that Fed policy remains easy.
Brean Capital economists expect Fed Chairman Jerome Powell to repeat that he won’t repeat the mistake of the 1970s, when the central bank loosened policy too quickly, allowing inflation to pick up again. Recent inflation gauges fell below four-year highs touched last year, largely due to falling energy and commodity prices, including used cars that rose during the pandemic.
However, Powell highlighted non-residential core services prices as key indicators of future price trends. It is observed that the increase in prices of non-residential services mainly stemmed from labor costs. Powell highlighted the tightness of the job market, which is reflected by the historically low unemployment rate of 3.5% and new unemployment insurance claims below 200,000.
However, in what BCA Research called a keynote, Fed Vice Chairman Lael Brainard pointed out that these non-residential service costs are rising more sharply than labor expenses, as measured by the Employment Cost Index.
If so, it can be concluded that these inflation measures could relax faster than the ECI, perhaps as a result of shrinking profit margins. In any case, a reading on the fourth quarter ECI It will be released on Monday, the day before the members of the Federal Open Market Committee meet.
Highlighting the lag between the Fed’s actions and their impact on the economy, Brainard was reported by the Washington Post last week as being shortlisted to replace Brian Deese as head of the National Economic Council. Going to the White House removes a key voice in favor of moderating the pace of monetary policy tightening.
At the same time, as the federal funds rate approaches restrictive levels, general financial conditions ease. This was reflected in the reduction in long-term borrowing costs such as mortgage rates; corporate credit, especially in the high-yield market, which has recovered in recent weeks; stock prices rose smartly from October lows; sharply declining volatility for equities and fixed income securities; and the decline in the dollar is a big boon for exports.
In any case, if the FOMC’s statement mentions “ongoing” rate increases, it will serve as a clue to the central bank’s thoughts on future rates. Alternatively, the phrase may emphasize that policy will become data-dependent.
If so, economic releases such as the jobs report due Friday morning and subsequent inflation readings will gain even more importance. The economists’ call for consensus is that nonfarm payroll growth has declined from 223,000 in December to 185,000 in January. The December Job Postings and Workforce Turnover Survey, or JOLTS, arrived Wednesday morning in time for the FOMC to consider.
Powell’s press conference after the meeting will also give important signals. It is certain that after the rush of layoffs from tech companies, they will be asked whether the working conditions are tight. And it’s certain to be questioned about the huge gap between what the market sees for rates and what’s projected in the Fed’s December Summary of Economic Projections, which won’t be updated until March.
The only certainty is that the debate on monetary policy will continue.
write this Randall W. Forsyth email@example.com
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