Will “ongoing” be outgoing at the Federal Reserve? Or will that keyword remain in the central bank’s policy guideline?
Such a seemingly trivial question could affect interest rate developments when the Federal Open Market Committee announces the results of its two-day meeting next Wednesday afternoon.
The Fed’s policymaking panel will almost certainly raise the target for federal funds to 4.50%-4.75%. That would amount to a cut to a 25 basis point hike, the FOMC’s usual interest rate move until last year, when it was catching up on normalizing its monetary policy, which had previously been very simple. The commission imposed four super-sized 75 basis point increases 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 “anticipates continued increases in target range.” Keeping the plural of the word “increases” in the policy statement would imply at least two more increases of 25 basis points, most likely during the confabs of March 21-22 and May 2-3. That would raise the Fed funds target range to 5%-5.25%, matching the median 5.1% single-point forecast in the FOMC’s most recent Summary of Economic Projections, released 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 hike at its March meeting. And after keeping the interest rate target at 4.75%-5%, the market is currently expecting a 25 basis point cut the day after Halloween, back to 4.50%-4.75%. That would put the key policy rate about half a point below the FOMC’s average year-end projection, and below 17 of the committee members’ 19 projections.
The Treasury market is also battling the Fed. The two-year bond, the most sensitive to interest rate expectations, traded Friday at a yield of 4.215%, below the lower end of the current target range of 4.25%-4.50%. The Treasury yield curve peaks at six months where T-bills trade at 4.823%. From there, the curve slopes down, with the 10-year benchmark at 3.523%. Such a configuration is a classic signal that the market sees lower interest rates ahead.
A series of Fed speakers have spoken positively about slowing the pace of rate hikes in recent weeks, pointing to a 25 basis point hike on Wednesday. But they all stuck to the message that monetary policy will stay on track to bring inflation back to the central bank’s target of 2%.
Based on the latest reading of the central bank’s preferred measure of inflation, the personal consumption deflator, it is too early to say that policies are restrictive enough to achieve that goal, argue John Ryding and Conrad DeQuadros, the veteran Fed watchers at Brean Capital. Data released on Friday showed that the PCE deflator is up 5.0% year over year. So even after the likely increase in Fed funds this coming week to a target range of 4.50%-4.75%, inflation-adjusted policy rates would still be negative, indicating that Fed policy remains accommodative.
Brean Capital economists expect Fed Chairman Jerome Powell to repeat that the central bank will not repeat the mistake of the 1970s when it eased policy too quickly, causing inflation to accelerate again. Recent inflation gauges have fallen below last year’s four-decade highs, largely due to easing prices for energy and goods, including used cars, which soared during the pandemic.
But Powell has emphasized core non-housing service prices as key indicators of future price trends. The increase in prices for non-housing services is mainly caused by labor costs. Powell has highlighted tightness in the labor market, reflected in an all-time low unemployment rate of 3.5% and new unemployment insurance claims falling below 200,000.
But in what BCA Research calls an important speech, Fed Vice Chairman Lael Brainard noted that these nonhousing service costs have risen more than labor costs, as measured by the Employment Cost Index.
If so, one might conclude that these inflationary measures could ease faster than the EBI, perhaps due to shrinking profit margins. In any event, a reading on the fourth quarter ECI will be released on Monday, a day before the members of the Federal Open Market Committee meet.
Brainard was shortlisted last week to replace Brian Deese as head of the National Economic Council, according to the Washington Post. If she leaves for the White House, it would remove an important voice for moderating the pace of monetary policy tightening.
While the fed-funds rate has moved closer to restrictive levels, overall financial conditions have eased. This is reflected in the decline in long-term borrowing costs, such as mortgage rates; corporate credit, especially in the high yield market, which has risen in recent weeks; stock prices, up sharply from their October lows; volatility, which has declined sharply for equities and fixed income; and the fall in the dollar, a great boon for exports.
In any case, if the FOMC statement speaks of “continued” rate hikes, that will serve as a clue to the central bank’s thinking about future rates. Alternatively, the statement could emphasize that policy is becoming data-dependent.
If so, economic releases, such as Friday morning’s jobs report and subsequent inflation numbers, will become even more important. A further slowdown in nonfarm payroll growth, to 185,000 in January from 223,000 in December, is the consensus among economists. The December release of the Jobs Openings and Labor Turnover Survey, or JOLTS, arrives Wednesday morning, in time for the FOMC to consider it.
Powell’s post-meeting press conference will also send important signals. He will certainly be asked whether working conditions will remain tight after the wave of job losses by tech companies. And he will no doubt be questioned about the wide gap between what the market sees for interest rates and what is predicted in the Fed’s December summary of economic projections, 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 firstname.lastname@example.org