Jerome Powell, Chairman of the US Federal Reserve, concluded 2023 on an optimistic tone, adopting a dovish message on December 13, along with expectations that showed that most Federal Committee members belong to the camp that believes in a soft landing.
The committee, which sets interest rates, believes unemployment will rise slightly above current levels, with inflation showing further progress towards stabilizing near policymakers’ target of 2%.
This progress means, as we move forward into the new year, that most people are now likely to announce the end of the Fed’s rate hike cycle, which has seen an official increase of 525 basis points since March 2022, the highest levels in 22 years, but the big question is to what extent it will be… Interest rate reduction.
The year 2023, which saw better-than-expected growth in the United States outpacing almost all other advanced economies and a sharp decline in inflation, has set the stage for officials to forecast that they will make three quarter-point cuts in interest rates over the next 12 months.
However, many investors are expecting more than that, with forward pricing deals taking place amid expectations that interest rates will fall 6 times in 2023.
Currently, economists’ bets fall somewhere in the middle between what officials and markets expect. One explanation for this discrepancy is the lack of clarity in how the US central bank thinks about financial conditions.
In early November, Powell sounded the alarm about excessive tightening in financial conditions. In the six weeks leading up to the last meeting in 2023, the US government’s 10-year financing costs rose about 50 basis points to 4.88%, while interest on a 30-year mortgage reached 7.79% on October 26.
It was the highest level recorded since 2000, and this actual tightening of financial conditions resulted in the Fed adding bold text in its policy statement: “Tightening financing and credit for households and businesses is likely to affect economic activity, employment and inflation.” The extent of these repercussions remains uncertain.”
These two words may not seem like they mean much, but to Fed watchers, they were enough to indicate that officials felt as if markets were pricing risks for them in performing some of their tasks, which meant less need to consider raising rates. But financial conditions deteriorated dramatically in the six weeks leading up to the December vote, with 10-year bond yields falling to 4.2%.
Bets on reducing interest rates contributed to reducing 30-year mortgage rates to slightly more than 7%, and this led some to speculate, ahead of the December meeting, that the Fed would abandon the reference to “tight” financial conditions.
But the signal remained present at the meeting, which means further easing in borrowing costs will be tolerated.
Many were also surprised by the direct question that Nick Timiraos, from the Wall Street Journal, asked Powell about how he felt about the markets facilitating policy on his behalf. The Fed Chairman seemed optimistic and confident, and he answered that despite the markets’ movements “back and forth,” he and his colleagues Of the committee members, they were “just focused on what the right thing to do is.”
Powell also said that it is necessary for financial conditions to be in line with what policymakers are trying to achieve in the long term, and that this is what will happen “eventually,” but that it is difficult to see how to reach this stage, in an environment characterized by the Fed’s responses to fluctuations in the markets. Finance with ambiguity.
So how much easing would be too much? Since the meeting, 10-year Treasury bond yields have fallen to 3.88%, and 30-year mortgage interest rates have reached 6.61%.
Reactions from other FOMC members suggest that some interest rate policymakers are not keen on pricing the market, which is actually pushing them to cut rates in March. Otherwise, economists say the matter is less clear.
“Not long ago, the Fed talked about the market doing some work for it,” said Andrew Patterson, an economist at Vanguard. “Right now, stocks have been up for seven or eight weeks in a row.” Investors are no longer helping to reduce inflation. In fact, we believe that the opposite is happening now.”
As for Gavin Davis, Chairman of the Board of Directors of Fulcrum Asset Management, he believes: “The lack of consistency in guidance regarding the importance of the financial conditions indicator gives you the impression that they are determined, and then they start looking for evidence to support their positions.”
He added: “What’s puzzling is that when the evidence changes, they don’t necessarily change with it.” There may be more evidence in the minutes of the December vote, due to be released in the coming weeks.
If the Fed achieves its goal, and it is proven that its shift towards a soft landing camp was the right choice, it may remain very pleased with the facilitation of financial conditions. But evidence suggests that inflation is more sustainable than expected, which could result in a rebound.
My best bet is that the Fed’s forecasts will prove reasonably correct, and that its communication will be clearer, with data confirming the easing of price pressures in the US.
Until then, expect some uncertainty in deciphering how US monetary policymakers think about how markets will price events.
Jerome Powell adopted a facilitative message on December 13…and most of the Federal Committee members showed their belonging to the camp that believes in a soft landing.
2024-01-05 22:02:15
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