It may not be classified with former European Central Bank President Mario Draghi’s “whatever it takes” vote, but President Jerome Powell made it clear Wednesday that the Federal Reserve would make up for lost time by steadily raising interest rates and reducing its budget to lower inflation to a four-decade high.
The bond market apparently believes that the US central bank can accomplish this goal. Long-term Treasury yields actually follow the Federal Open Market Committee’s new projections that call for further quarter-point hikes in the federal funds target range at each of the six remaining meetings this year. This was much more significant than the FOMC’s actual quarter-point increase in its key benchmark rate announced after its two-day confab, to a range of 0.25% -0.50%, which was expected after. that Powell had almost promised it earlier in recent Congressional testimony.
The 30-year Treasury yield fell 3.8 basis points (100ths of a percentage point), to 2.442%. But the two-year note, the most anticipated coupon maturity for the Fed’s future policy, jumped 6.6 basis points, to 1.934%, the highest since June 2019. The 10-year benchmark yield is climbed three basis points, to 2.18%, which was nearly equal to the five-year note at 2.176%, up 6.9 basis points on the session.
All of these moves in the Treasury market add up to a marked flattening of the slope of the yield curve, a classic signal that the market expects a slowdown in real growth along with a possible decrease in inflationary pressures.
The stock market, for its part, has welcomed this rather aggressive outlook for Fed policy in a surprisingly bullish way. The major averages reversed previous losses and rose following the FOMC announcement of 2pm Eastern Time and through Powell’s subsequent press conference. The major averages came in from 3.77% for the Nasdaq Composite to 1.55% for the Dow Jones Industrial Average, while the S&P 500 index was up 2.24%.
The rebound in the stock market suggests that Fed monetary tightening will be able to ease inflationary pressures without hurting economic growth or profits. Such an outcome would be highly desired but less likely.
The bond and equity markets are spinning in circles regarding their respective prospects, notes Julian Brigden, president and co-founder of Macro Intelligence Partners. The debt market continues to underestimate the degree of tightening expected in the latest FOMC projections.
The so-called dot plot of committee estimates for the end of 2023 ranges from 2.4% to 3.1% and in 2024 from 2.4% to 3.4%, with a median of 2.8% at the end of both. years. This would be above the committee’s estimate of the long-run fed-funds equilibrium rate of 2.4%; translation, tight rather than easy, money.
The stock market appears to be overly optimistic about this hawkish outlook, Brigden adds in a telephone interview. Powell pointed out in his press conference that the Fed looks at a variety of indicators to gauge financial conditions. As long as the stock market remains positive, Brigden says the Fed will continue to tighten.
In addition to the dot plots, which imply the Fed would raise the federal funds rate by 25 basis points every meeting this year, Powell added to his press that if inflation didn’t subsidize as expected while the economy remained strong. , the central bank could raise tariffs more. As if to underline the Fed’s aggressive stance, Wednesday’s vote to begin rate hikes included dissent from St. Louis Fed chairman James Bullard, who preferred a half-point hike.
Nor has the Fed been deterred from starting to raise rates from the impacts of the Russian war against Ukraine, Brigden also pointed out. And in response to a question at his press conference, in hindsight, Powell admitted it would have been preferable for policy normalization to have begun earlier as factors such as supply chain problems have not eased as quickly as he expected. the Fed.
Finally, Powell was also keen to point out that the Fed was ready to announce the start of the outflow of its holdings in securities. The central bank had more than doubled the size of its balance sheet to nearly $ 8.9 trillion since the start of the Covid-19 pandemic in March 2020, which had the effect of a massive expansion of liquidity in the financial system.
Powell said the FOMC could announce plans for a tightening of its budget as early as its next meeting on May 3-4. He indicated that the budget ballot would be faster and would start earlier than the previous episode in 2017-2018 https://www.stlouisfed.org/open-vault/2019/july/what-is-quantitative-tightening# : ~: text = The% 20Fed’s% 20Balance% 20Sheet% 3A% 20Runoff & text = The% 20caps% 20started% 20at% 20% 246,% 2420% 20billion% 20per% 20month% 2C% 20 when the central bank has allowed the securities to mature after its quantitative easing in response to the 2008-2009 financial crisis. The reduction in holdings of securities this time around could be equivalent to one or two more federal fund rate hikes.
Powell stressed that the Fed would be alert to market conditions and support financial stability as the central bank normalized policy. History shows that when the Fed tightens policy, bear markets and recessions tend to follow.
Given the stock market’s exuberant reaction to Wednesday’s policy announcement, he apparently believes the worst has already been priced in in the modest withdrawal of major averages from their recent highs. But that’s different this time.
Write to Randall W. Forsyth at firstname.lastname@example.org