Stock and bond markets have sold off every day since Fed Chair Powell’s remarks last Friday at the Jackson Hole Economic Policy Symposium. His eight-minute speech mentioned the word inflation over 40 times. Any hopes of the famous, or infamous, “Fed put” being invoked in this cycle were wiped out as he said, “While higher interest rates…will bring down inflation, they will also bring some pain.” He also set markets straight as to the “schedule” of upcoming rate hikes.
The 75 basis point increase in September is now at 70% likelihood in the futures markets. Markets expect increases of another 75 basis points total at the November/December meetings. That would bring the Fed Funds target rate up to 3.75% – 4.25% to open in 2023. That is right where several Fed officials are pegging the “Terminal Rate” – the highest rate hike in this cycle. Markets were assuming that the Fed would then “pivot” relatively quickly with rate cuts in response to a slowing economy. But Powell‘s comment on Friday sought to tamp down those expectations: “Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.” NY Fed President John Williams chimed in on Tuesday in a live interview: “We’re going to…have restrictive policy for some time…This is not something we’re going to do for a very short period.” He chimed in on the Terminal Rate speculation, saying that “we do need to get real interest rates…above zero.” “Real interest rate” = the nominal interest rate minus inflation. Positive real interest rates would mean setting the Fed Funds rate above the inflation rate. Core PCE is at 4.6% today. Assuming inflation drops to about 4.0% early next year, Williams is estimating the terminal rate at about 4.00% – 4.25%. All of this “forward guidance” has therefore upended market expectations of the pace of rate cuts in 2023. This is causing the 10 Year Treasury to increase as it closed today at 3.21%. Of course, everything is data dependent – but officials are stressing that a change in this stated policy will require a sustained and unambiguous downward trend, not just “a few reports.” Stay tuned…
By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
