Lather, Rinse, Repeat: The Fed Once Again Does The Expected And Hikes Rates
Lather, Rinse, Repeat: The Fed Once Again Does The Expected And Hikes Rates
And Once Again The "Pivot" Narrative Takes It On The Chin
In a move that surprised exactly no one, the Federal Reserve once again stuck religiously to the “Volcker Playbook” and instituted yet another 75bps rise in the Federal Funds Rate at the conclusion of the November Meeting of the Federal Open Market Committee.
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 3-3/4 to 4 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve's Balance Sheet that were issued in May. The Committee is strongly committed to returning inflation to its 2 percent objective.
And in a move that once again dashed the hopes of Wall Street for a Fed “pivot”, in the press conference that followed, Federal Reserve Chairman Jerome Powell reiterated his firm support for continued tightening of monetary policy.
With today’s action, we’ve raised interest rates by 3 ¾ percentage points this year. We anticipate that ongoing increases in the target range for the federal-funds rate will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.
Financial conditions have tightened significantly in response to our policy actions, and we are seeing the effects on demand in the most interest-rate-sensitive sectors of the economy, such as housing. It will take time, however, for the full effects of monetary restraint to be realized, especially on inflation. That’s why we say in our statement that in determining the pace of future increases in the target range, we will take into account the cumulative tightening of monetary policy and the lags with which monetary policy affects economic activity and inflation.
Market Reactions Also Stuck To The Expected Path
What should also have come as a surprise to no one is the Wall Street reactions to the Fed’s latest rate hike.
Immediately after the Fed’s announcement, the major equity indices all nosedived….again.
While some attempt at recovery was made on Thursday, as of this writing markets remained significantly below pre-announcement levels.
At the same time, Treasury yields jumped, with the 10-year yield peaking Wednesday afternoon at 4.1030%, and rising even further at Thursday’s opening.
Forex markets also rewarded the Fed’s rate hikes, as the dollar strengthened significantly against the yuan, the yen, the euro, and the pound sterling.
In all, there were the formulaic responses to the formulaic Fed rate hike.
The “Pivot” Narrative Refuses To Die
Despite this being the Fed’s fourth 75bps rate hike in a row, Wall Street continues to expect a coming “pivot”, as markets melt down into a general liquidity crisis.
Even economist Nouriel Roubini keeps reiterating the narrative theme that the Fed will at some point “wimp out” and switch from tighter to looser monetary policy.
Once the Fed is going to essentially prevent an economic and financial crash – or try to prevent it by … stopping raising rates, even though inflation is too high, then the dollar is going to start to sharply weaken. That is going to be the trigger for it. Because what is raising the dollar is tight monetary policy.”
One has to wonder how much of this is wishful thinking on the part of Wall Street, given that Powell stated outright at Jackson Hole that he was willing to not merely risk a recession but even cause one in order to get inflation down around 2%.
Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.
Whether Powell “should” keep raising rates is a question worthy of some debate—and I’ve argued more than once that Powell’s rate hikes are not going to achieve the outcomes he want. However, that question is separate and distinct from whether or not Powell is likely to “pivot” away from rate hikes in order to stave off either a market meltdown or an economic crisis.
That the dollar has strengthened considerably against other major currencies since the Fed began raising rates gives Powell considerable incentive to hold the line on rate hikes—a reality that Wall Street keeps choosing to ignore.
Moreover, if one goes by just the top-level numbers put out by the BEA last week, the economy is for the moment more or less healthy (whether the detail underneath supports that assessment is a different story).
All of this makes the notion of a quick Fed “pivot” away from rate hikes an unlikely scenario. Until there is a dramatic turn of economic events, Wall Street pricing in a Fed “pivot” is little more than a financial fever dream.
For Better Or Worse, The Rate Hikes Will Continue
While I have argued before that Powell’s rate hikes are not working, right now the Fed is committed to enacting what it sees as a replay of former Fed Chair Paul Volcker’s strategy on containing inflation. So long as Jay Powell is committed to that course of action, the rate hikes will continue.
Thus far, Powell’s rate hikes have had the inarguable benefit of strengthening the dollar against other major currencies—and that is no small benefit in a global economic situation where just about everyone, from China to the EU to the United States, is facing a worsening economic contraction. While the rate hikes are proving useless against inflation, at the very least they are making it more likely that, in what has become a global economic race to the bottom, the dollar wins simply by virtue of coming in last.
Still, the rate hikes themselves are not likely to prevail against the supply-side forces that are pushing prices up.
Raising interest rates will not alter the economic impact of a nationwide railroad strike—the possibility of which has been rising of late.
Raising interest rates will not alter the projected increases in energy costs as winter approaches.
Interest rates restrain prices by squelching demand. When the forces driving up prices are ultimately shocks to or constraints in supply, interest rate hikes are always going to come up short as a strategy for mitigating inflation.
Higher interest rates might not have as much effect as is desired, but they've been kept artificially low for far to long and are finally being allowed to revert to something resembling market rates.
There's also a good argument to be made that the Fed isn't really raising them. Check out short-term T-bill rate charts. One might almost conclude that the Fed is really only matching what the markets have already done.