Regular readers know Financology doesn’t indulge in the financial media obsession with trying to handicap the number of rate hikes that will occur before a certain arbitrary date on the calendar, what the exact size of the next hike will be or what the effective Fed funds rate will be on any particular date. Investors can find all that’s relevant and knowable about the course of short term interest rates in the Treasury yield curve.
But we stand at an unusual juncture, and it might be amusing if not informative to speculate directly on the next few FOMC policy announcements. As much heathy respect as we have for the wisdom of the bond market, we suspect it might not have everything quite right.
Let’s not call this a forecast … more of a plausible scenario that is at least worth allowing for in our portfolio planning. The Fed hikes 75 bp at its upcoming meeting on September 21. Nothing out of the ordinary about that … it’s what the markets have priced in today. But bear with me … the Fed hikes 75 bp at its upcoming meeting on September 21 … and then … stops. This the market does not have priced in.
What? The next meeting is November 2. The operative hypothesis is that by then, the early signs of victory over inflation will by then have become obvious to all. Oh, YOY CPI won’t have crashed … but the stock market may well have. This would supply all the “tightening of financial conditions” the Fed seeks … and maybe then some. And the proximate trigger for that would be an obvious deterioration in corporate profits due to the lagged effects of higher rates and yields that have already taken place, on top of household budgets already having been painfully stretched by rampant consumer price inflation, finally crushing consumer spending. Details may vary, but the broad strokes are not out of the realm of plausibility. Not to mention that other global issues, from general European collapse due to energy shortages to China collapse due to implosion of its real estate bubble, are all ready and waiting for their place in the headlines. That 2023 could be an ugly year might by then be a hard to deny prospect.
Again this is not a forecast. But even if it doesn’t come to pass, it seems unlikely the Fed will continue to hike at a 75 bp per meeting pace. It has deliberately “front-loaded” policy tightening in an effort to compensate for having fallen so far behind the curve earlier. If, as appears likely, it follows through with a third consecutive 75 bp hike in 13 days, that “front-loading” may well succeed.
3 thoughts on “Federal Reserve Outlook”
powell has said that he doesn’t want policy to be forward looking, i.e. he doesn’t want to react to what has yet to actually occur. if he sticks to that, it would mean he would have to see substantial progress in lowering inflation before he backs off from rate hike after rate hike. and of course inflation numbers are lagging.
first, do you agree that this is what he’s said?
second, if he follows this dictum, when do you think he’ll see enough softening of inflation to justify the end, or at least a pause, of his hiking campaign? it’s hard for me to believe this condition could be met by october.
Good question … I’d hesitate to draw any firm conclusions without the exact language and full context, and I don’t recall that. But I agree inflation stats are backward looking … if he were to wait until YOY CPI or PCE were back to 2%, he would definitely be late. Even current CPI, if you knew it, would lag since consumer prices are well down the inflation pipeline.
Asset prices are the first responders, so from that point of view a stock market crash would actually justify backing off. (The Fed has done this before, but then left its foot on the accelerator. Classic examples include 2008 and 2020. This is where the trouble begins.)
In other words, we wouldn’t actually expect measures of consumer price inflation to come down anywhere near enough by November to justify halting the policy tightening. But a big retreat in asset prices would supply the tightening of “financial conditions” the Fed seeks, giving it justification to pause.
Whether this would qualify as “forward looking” is more of a philosophical question. Sure it would be if you’re only looking at consumer price inflation, but asset prices are real data too.
Anyway this would be the scenario that could make the September hike the last of this cycle. The next meeting is in November, so an October crash would do it. Again though this is just one possible scenario … sort of a bookend at one end of a spectrum that would have the expectations of hikes as far as the eye can see at the other.