Will “ongoing” be outgoing at the Federal Reserve? Or will that key word remain in the central bank’s policy directive?
On such a seemingly trivial question may hang the course of interest rates when the Federal Open Market Committee announces the results of its two-day meeting this coming Wednesday afternoon.
The Fed’s policy-setting panel is all but certain to raise its federal-funds target range to 4.50%-4.75%. That would represent a downshift to a 25-basis-point increase, the FOMC’s usual rate move until last year, when it was playing catch-up in normalizing its monetary policy, which previously was uber-easy. The committee imposed four supersize 75-basis-point hikes in 2022 and then added a 50-basis-point increase in December. (A basis point is 1/100th of a percentage point.)
At that time, the FOMC stated that it “anticipates that ongoing increases in the target range will be appropriate.” Retaining the plural word “increases” in its policy statement would imply at least two more 25-basis-point hikes, most likely at the March 21-22 and May 2-3 confabs. That would boost 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 December’s meeting.
But the market doesn’t believe this. As the chart here shows, the fed-funds futures market is pricing in only one more increase at the March meeting. And after holding its rate target at 4.75%-5%, the market currently anticipates a 25-basis-point cut the day after Halloween, back to 4.50%-4.75%. That would put the key policy rate about a half-point under the FOMC’s median year-end projection, and below 17 of the 19 committee members’ forecasts.
The Treasury market also is fighting the Fed. The two-year note, the maturity most sensitive to rate expectations, traded Friday at a 4.215% yield, below the bottom end of the current 4.25%-4.50% target range. The peak of the Treasury yield curve is at six months, where T-bills trade at 4.823%. From there, the curve slopes lower, with the benchmark 10-year note at 3.523%. Such a configuration is a classic signal that the market sees lower interest rates ahead.
An array of Fed speakers in recent weeks have spoken favorably of downshifting the pace of rate hikes, pointing to a 25-basis-point hike Wednesday. But they’ve all stayed on message that monetary policy will stay the course to get inflation back to the central bank’s target of 2%.
Based on the latest reading of the central bank’s favored inflation measure, the personal consumption expenditure deflator, it’s too early to say policy is sufficiently restrictive to reach that goal, argue John Ryding and Conrad DeQuadros, the veteran Fed watchers at Brean Capital. Data released Friday showed the PCE deflator up 5.0%, year on year. So, even after the likely fed-fund increase this coming week, to a 4.50%-4.75% target range, the key rate would still be negative when adjusted for inflation, indicating that Fed policy remains easy.
The Brean Capital economists expect Fed Chairman Jerome Powell to reiterate that the central bank won’t repeat the error of the 1970s when it eased policy too quickly, allowing inflation to reaccelerate. Recent inflation gauges have slid below the four-decade highs touched last year, largely because of eased prices for energy and goods including used cars, which soared during the pandemic.
But Powell has emphasized non-housing core service prices as key indicators of future price trends. The rise in non-housing service prices are seen to be driven mainly by labor costs. Powell has emphasized the tightness of the jobs market, which is reflected in a historically low unemployment rate of 3.5% and new claims for unemployment insurance running below 200,000.
But in what BCA Research calls an important speech, Fed Vice Chair Lael Brainard noted that these non-housing service costs have risen more sharply than labor expenses, as measured by the Employment Cost Index.
If so, one might infer that these inflation measures might ease faster than the ECI does, perhaps as a result of narrowing profit margins. In any case, a reading on the fourth-quarter ECI will be released Monday, a day before the Federal Open Market Committee members get together.
Brainard, who has emphasized the lag between Fed actions and their impact on the economy, was reported by the Washington Post last week to be on a shortlist to replace Brian Deese as head of the National Economic Council. If she leaves for the White House, that would remove a key voice in favor of moderating the pace of monetary policy tightening.
At the same time, while the fed-funds rate has moved closer to restrictive levels, overall financial conditions have been easing. That’s reflected in the decline in long-term borrowing costs, such as mortgage rates; corporate credit, especially in the high-yield market, which has rallied in recent weeks; stock prices, up smartly from their October lows; volatility, which has receded sharply for equities and fixed-income securities; and the slide in the dollar, a major boon for exports.
In any case, if the FOMC’s statement speaks of “ongoing” rate hikes, that will serve as a clue to the central bank’s thinking about 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 greater import. A further deceleration in nonfarm payroll growth, to 185,000 in January from December’s 223,000 is the consensus call by economists. The December Jobs Openings and Labor Turnover Survey, or JOLTS, release arrives Wednesday morning, in time for the FOMC to ponder.
Powell’s postmeeting press conference also will send important signals. He is certain to be asked whether labor conditions remain tight after the flurry of job cuts by tech companies. And he is sure to be quizzed about the wide gulf between what the market sees for rates and what is predicted in the Fed’s December Summary of Economic Projections, which won’t be updated until March.
All that’s certain is the debate over monetary policy will be ongoing.
Write to Randall W. Forsyth at firstname.lastname@example.org