First off, a 75 basis point increase for the 4th straight meeting put the Fed Funds rate at 3.75% – 4.00%, the highest since 2008. Prime Rate is 7.00%, 30-Year fixed rate home loans are about 7.30% and 30-Day Term SOFR is 3.79%. Markets rallied on “dovish” comments in the initial statement: “In determining the pace of future increases, the Committee will take into account the cumulative tightening…. (and) the lags with which monetary policy affects inflation.” Many economists note that Fed actions take time to work through the economy. A scenario where the Fed watches and waits while lagging indicators catch up could forestall economy-crushing excessive rate increases, aka the “soft landing.” Hopes of “the pivot rally” jumped as the 10-Year Treasury yield dropped to 3.98 from 4.06 and the Dow rallied over 300 points in 30 minutes… until Fed Chair Powell’s remarks and responses to questions. His opening remarks seemed like a direct response to domestic and international pressure on the Fed to ease off on rate increases. He reiterated that the Fed’s number one job is price stability and that a sustained healthy labor market depends on that stability. The irony in that statement is that fighting inflation will require more slack in the labor market, i.e. higher unemployment. It’s as if the Fed needs to “break employment to save it.” The phrase that really moved markets was: “It’s very premature to think about pausing”, which he repeated for emphasis. Powell recognized that conditions have already tightened in housing, business investments, and other rate-sensitive sectors. He noted that goods prices should have come down faster and that prices for services are rising significantly. Yesterday’s ADP report for September indicated robust hiring continues in the services sector – especially hospitality and leisure.
Future Direction: Powell indicated that the Fed might “slow the pace” of rate cuts in December and February. But the data point that really shook the markets was his response to the big questions which are: “How high?” and “How long?” – regarding the “terminal rate” or peak and how long before the next rate cut. It seems like the answers are “higher” and “longer.” Powell said that there is now “significant uncertainty” amongst Fed policymakers about the “ultimate level” for the Fed Funds rate. This follows recent comments by Fed President Kashkari that a “terminal rate” in the 5% range may be needed to battle core PCE inflation. Recent assumptions had the terminal rate at about 4.6% and hopefully peaking for a few months. Powell and the Fed are now setting expectations for a longer battle. Rhetoric such as “Some ways to go” and the recent mantra “Restrictive territory… for some time” drove the message home.
In the weeds: Powell discussed employment metrics he is closely following: job quits, vacancies and labor participation. The Fed is watching for any sign of slack in the labor markets. He also discussed softening rental rates and the inherent housing cost lag in the CPI statistics. CPI continues to count rental costs based on all lease payments, not just newly signed lease costs. This may understate the effect of Fed rate increases on housing costs for months. He noted that this lag is considered when reading the data. The rallies dissipated into negative territory as markets digested Powell’s remarks – the 10-Year jumped to 4.11% and the Dow dropped 1.5%. Stay tuned…
By David R. Pascale, Jr., Senior Vice President at George Smith Partners