The Fed Raises Rates...Sort Of
Does It Count When The Markets Ignore The Fed?
As expected—almost as if on cue—the Federal Open Market Committee raised the Federal Funds rate by 50bps on Wednesday. With its last rate hike of 2022, the Fed officially brought the Federal Funds Rate to 4.5%.
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 4-1/4 to 4-1/2 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.
Interest rates in this country are now at least 4.5%, right? Well….maybe not. Bond market reactions to the Fed rate hike are mainly….nonexistent.
With each successive rate increase, the Fed has moved Treasury yields up less and less. To make matters even more complicated, since the last rate hike, Treasury yields across the yield curve have actually fallen, with the result that the upper limit of the Federal Funds target rate is higher than the yield for 2-, 5-, and 10-year Treasuries. Only the 1-year Treasury yield is (barely) above the Federal Funds Rate.
While immediately after previous rate hikes, Treasury yields move up almost immediately on the announcement of the rate increase, there have been no clear pricing signals on Treasury debt after this most recent increase.
The 10-Year Treasury yield has fallen since Wednesday’s rate announcement.
The 2-Year Treasury yield has largely moved sideways in the day’s trading since the rate increase announcement.
Even the 3-Month Treasury yield has been indifferent to the Fed’s rate increase.
Across the yield curve, the markets have simply ignored the Fed’s rate hike, instead of following the Federal Funds rate higher.
Nor is it simply Treasury yields that are proving indifferent to the Fed’s efforts to raise interest rates of late.
Both the 30-year and 15-year fixed rate mortgage average in the US have been declining since the beginning of November, and this week’s update has continued that trend.
Even corporate bond yields have been declining since late October.
As consumer price inflation has declined in recent months, real yields on Treasuries have move somewhat less negative, but the decline in consumer price inflation is matched by a decline in the 10-year Treasury yield, greatly slowing the trend of real treasury yield growth.
As I observed this time last month, you cannot push a string, and that is exactly what the Fed tried to do with this latest rate hikes.
Only equity markets seemed to react to the Fed’s rate hike announcement, with all major stock indices closing down sharply on Wednesday.
A full day after the Fed raised the Federal Funds rate, and, as far as Wall Street is concerned, interest rates have moved lower, along with the stock markets. For all intents and purposes, the Fed has simply failed to move the interest rate needle with a 50bps rate hike.
Would another 75bps rate hike been more impactful? Perhaps, but even at 75bps the influence of the Federal Reserve over interest rates has been itself in pronounced decline. If a 50bps rate hike has no discernible impact on interest rates, it is unlikely that a 75bps rate hike would have had a significant impact on interest rates.
What becomes of the Fed’s inflation-fighting strategy if rate hikes in the Federal Funds rate cease to cause market interest rates to rise? That is difficult to assess, but it is hard to expect the effect of sudden Fed impotence to be anything good.
Yet that is where the Fed’s inflation-fighting strategy stands. Bond markets have almost completely ignored the Fed rate hikes, and are now moving independently of the Federal Funds rate.
Last month former Treasury Secretary Larry Summers speculated that the Fed’s “terminal” interest rate would have to be 6% or more in order to get inflation under control, and I questioned if the Fed could even get interest rates to 6%.
Based on Wall Street’s reaction (or lack thereof) to this latest rate hike, it will take draconian rate hikes, on the scale of a couple hundred basis points at a time, for the Federal Funds rate to have any hope of pulling market interest rates higher in keeping with the Fed’s inflation-fighting strategy. Even 75bps rate hike increments now appear too small to have the necessary impact on interest rates overall.
Proving once again that you cannot push a string, the Fed has also proven that it has all but lost control over interest rates. It never had control over inflation.
I think the Fed could easily push interest rates much higher if they really wanted to. They have something on the order of $8T in assets that they could sell. I don't know how much they'd have to sell, but a trillion or two over the course of a few months would certainly do the trick.
Of course there's a small problem with this approach. The more they sold and the higher the rates went as a result, the lower the market value of their remaining assets would go, because virtually all their assets were purchased at lower rates. This would quickly destroy what little equity they have on their balance sheet and then they'd technically be insolvent, which would be an interesting situation.
I heard a far greater unemployment rate was their desired aim. And we can figure out why.