Will the “ongoing” be outgoing at the Federal Reserve? Or will this key word remain in the policy directive of the central bank?
On such a seemingly trivial issue, the course of interest rates could hinge when the Federal Open Market Committee announces the results of its two-day meeting on Wednesday afternoon.
The Fed’s panel of policymakers is almost certain to raise its target fed funds range to 4.50%-4.75%. That would represent a move to a 25 basis point hike, the FOMC’s usual rate move until last year, when it caught up with the normalization of its monetary policy, which had previously been extremely easy. The committee imposed four supersize 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 that time, the FOMC said it “expects continued increases in the target range to be appropriate.” Retaining the plural word “increases” in its policy statement would imply at least two additional 25 basis point increases, most likely at the March 21-22 and May 2-3 conferences. That would push the target range for fed funds to 5%-5.25%, matching the single-point median forecast of 5.1% in the FOMC’s latest summary of economic projections, released at the December meeting. .
But the market does not believe it. As the chart here shows, the fed funds futures market is pricing in just one more increase at the March meeting. And after having maintained its target rate at 4.75%-5%, the market is currently anticipating a fall of 25 basis points the day after Halloween, to return to 4.50%-4.75%. That would put the policy rate about half a point below the FOMC’s year-end median projection and below 17 of the committee’s 19 forecasts.
The Treasury market is also fighting the Fed. The two-year note, the maturity most sensitive to rate expectations, traded Friday at a yield of 4.215%, below the lower end of the current target range of 4.25% to 4.50 %. The peak of the Treasury yield curve is at six months, where Treasuries are trading at 4.823%. From there, the curve slopes down, with the benchmark 10-year note at 3.523%. Such a pattern is a classic signal that the market anticipates lower interest rates.
A range of Fed speakers over the past few weeks have spoken favorably of the tapering pace of rate hikes, pointing to a 25 basis point hike on Wednesday. But they all stuck to the message that monetary policy will stay on course to bring inflation back to the central bank’s 2% target.
Based on the latest reading of the central bank’s favorite inflation measure, the personal consumption expenditure deflator, it’s too early to say the policy is tight enough to achieve that goal, say John Ryding and Conrad DeQuadros , the veteran Fed watchers at Brean Capital. Data released on Friday showed that the PCE deflator rose 5.0%, year-on-year. So even after the likely hike in fed funds this coming week, to a target range of 4.50% to 4.75%, the key rate would still be negative when adjusted for inflation, indicating that the policy of the Fed remains accommodative.
Brean 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 rise. reaccelerate. Recent inflation gauges have slipped below four-decade highs hit last year, largely due to lower prices for energy and goods, including used cars, which have soared skyrocketing during the pandemic.
But Powell pointed to the prices of basic non-housing services as key indicators of future price trends. The rise in prices for non-housing services seems to be driven mainly by labor costs. Powell pointed to a tight labor market, which is reflected in a historically low unemployment rate of 3.5% and new jobless claims below 200,000.
But in what BCA Research calls a landmark speech, Fed Vice Chairman Lael Brainard noted that these non-housing service costs have risen more sharply than labor spending, as measured. by the employment cost index.
If so, one could infer that these measures of inflation could decline faster than the ECI, perhaps due to shrinking profit margins. Either way, a reading on the fourth-quarter ECI will be released on Monday, a day before members of the Federal Open Market Committee meet.
Brainard, who pointed to the disconnect between Fed actions and their impact on the economy, was flagged by The Washington Post last week as being on a shortlist to replace Brian Deese as head of the National Economic Council. If she leaves for the White House, it would remove a key voice in favor of moderating the pace of monetary policy tightening.
At the same time, as the fed funds rate moved closer to restrictive levels, overall financial conditions eased. This is reflected in lower long-term borrowing costs, such as mortgage rates; corporate credit, particularly in the high yield market, which has recovered in recent weeks; equity prices, up sharply from their October lows; volatility, which fell sharply for equities and fixed income securities; and the fall of the dollar, a major boost for exports.
In any case, if the FOMC press release speaks of “ongoing” rate hikes, this will serve as a clue to the central bank’s thinking on future rates. Alternatively, the statement could emphasize that policy will become data dependent.
If so, economic releases, such as the jobs report due Friday morning and subsequent inflation readings, will take on even more significance. A further deceleration in nonfarm payroll growth, to 185,000 in January from 223,000 in December, is the consensus call from economists. The December Job Openings and Labor Turnover Survey, or JOLTS, arrives Wednesday morning, in time for the FOMC to think.
Powell’s press conference after the meeting will also send important signals. He will certainly be asked whether working conditions remain tight after the wave of job cuts by tech companies. And he’s sure to be asked about the wide gap between what the market sees for rates and what’s forecast in the Fed’s December economic projections summary, which won’t be updated until March.
All that is certain is that the monetary policy debate will continue.
Write to Randall W. Forsyth at email@example.com