The 10-Year Treasury is up to 3.10%, rising 32 basis points in the last 10 days. Markets are concerned that Friday’s speech by Fed Chair Powell will lay out a more hawkish path than markets expected earlier this month. He is expected to say that a recession will not stop the fight against inflation. The usual assumption is that the Fed will react to a slowing economy by swiftly lowering rates. This is known as the famous “Fed put.” The fear is that Powell may remove that put this Friday. The futures market is now predicting a 60% chance of a 75 basis point increase at the September 21st meeting. Remember, markets have whipsawed back and forth between predicting 50 basis points and 75 basis points multiple times in the last month. The Fed’s recent increases are hammering rate-sensitive sectors, such as housing. The National Board of Realtors said “We are in a housing recession,” as July saw the biggest monthly decline in prices since 2011. Tightening conditions are also hitting employers, both local and corporate. Large companies, like Oracle, Walmart, Apple, and Ford, have announced layoffs.
According to the latest PwC survey of US executives and board members, 52% of companies are instituting hiring freezes. Weekly jobless claims rose to an 8 month high this week. The Fed has made it clear that they are abandoning the long-standing “dual mandate” of full employment and price stability (sometimes referred to as the “2 and 4” rule – targeting a 2% inflation rate and a 4% unemployment rate). They now realize that the inflation-curbing “demand shock” that is being implemented must include a cooler job market in order to calm price pressures. Higher unemployment will be seen as “collateral damage” in the pursuit of wage and price stability. Yet, some sectors of the job market are still “hot” with job shortages. Prices continue to rise (albeit at a slower pace). September will see the Fed increase rates into restrictive territory above the “neutral rate” it’s at today (2.50-2.75%). Now the focus is “what is the terminal rate?” i.e., the peak rate. Powell may address that this week. The futures markets are pricing the peak at about 4.00% – 4.25%, occurring in the second quarter of 2023. The 2 Year Treasury (most sensitive to anticipated Fed increases) is at 3.39%, a 10 week high. This Friday is action-packed with the release of the July PCE index (the Fed’s preferred inflation gauge). The data will be intensely parsed for (hopeful) signs that inflation has peaked and is slowing. After that early morning release, the Powell speech. Stay tuned….
By David R. Pascale, Jr. , Senior Vice President at George Smith Partners