As widely expected, the Federal Open Markets Committee announced Wednesday that it will keep the Federal Funds rate unchanged. At the same time, 12 of 19 Fed officials suggested that the rate will be increased one more time this year — on November 1 or December 13. The remaining seven colleagues expect no further hike. The officials’ dot plot also showed that the interest rate will remain higher for longer during 2024 than they had signaled at earlier meetings.
None of this came as a major surprise to Treasury or equity markets when the FOMC decision was released at 2:00 pm Eastern time. There was little change in prices over the next 30 minutes. What provoked a broad-based sell off — reflected in major equity indexes as well as in yields on 10- and 30-year Treasurys — were the contents of the press conference that Fed Chairman Jerome Powell held starting at 2:30 pm. The correction in equities continued through the end of the week, while Treasurys followed the sharp rise in yields on Thursday with a small decline yesterday.
After making reference to the dot plot that showed individual Fed members’ views on where interest rates may be headed in coming months, the Chairman proceeded to belittle its importance. He pointed out that the forecasts are not “a Committee decision or plan.” He emphasized that he and his colleagues “will continue to make our decisions meeting by meeting, based on the totality of the incoming data and their implications for the outlook for economic activity and inflation as well as the balance of risks.”
In essence, Powell’s advice was for markets to ignore the dot plot that the FOMC puts out and, instead, watch his actions in response to future data.
That was not all that spooked financial markets. The Chairman went on to state that the central bank was “prepared to raise rates further if appropriate, and we intend to hold policy at a restrictive level until we are confident that inflation is moving down sustainably toward our objective.” With that statement, Powell put the kibosh on a rising consensus that the Fed was approaching the end of its tightening cycle. Instead, he indicated that he cannot forecast how much further rates will rise because that would depend on incoming data which, in turn, are unpredictable.
The combination of Powell’s statements discussing the continued strength of the US economy, the Fed forecast that unemployment will not increase significantly from the current 3.8%, and his determination to bring down inflation further, were all that investors needed to sell both equities and long-dated debt.
Having discussed what put markets into their deep funk, we turn now to whether the scenario that Powell painted is realistic. Will the Fed actually raise the Federal Funds rate several more times, continue to reduce its balance sheet at the same time, as inflation comes down further but stays above the 2% target?
If you believe that, I have a few bridges to sell you.
The Fed has increased rates 11 times since March 2022 from near-zero to a current range of 5.25 - 5.5%. The economy appears to have withstood the impact of the sharply higher rates combined with a reduction in the central bank’s balance sheet, stimulated by the massive fiscal spending and the monetary expansion that the Fed had played a major role in. In viewing the higher interest rates, it is easy to forget that the Fed’s balance sheet, already swollen at about $4 trillion at the inception of covid in early 2020, more than doubled to almost $9 trillion before the tightening began.
Today, in addition to the shift in Fed policy, the economy faces a possible government shutdown next weekend, an ongoing strike against all the three major US automakers, and the resumption of student loan repayments. While the first two factors could worsen supply bottlenecks, resumption of payments by students will constrain demand. While any one of these developments could prove to be a significant headwind, the simultaneous occurrence of these factors could cause “credit events.” This is the context in which Powell’s rhetoric should be seen.
These are the reasons why I believe that the Chairman and his colleagues will find it difficult to match his hawkish rhetoric with concrete action. An economic shock would cause a sharp reversal in policy involving interest rates being moved lower. In addition, expect a larger balance sheet (through Quantitative Easing), as was the case in March in response to the banking crisis.
The problem with aggressive statements is that they sow the seeds of their own destruction.
Dr. Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
srikumar@srikumarglobal.com
@SriKGlobal
September 23, 2023
Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.
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Agree with all your points, Daniele
i really don't get the Fed communication strategy: a trader might be driven by incoming data, a central bank must show a more anchored framework and provide comfort they know what they are doing. and on top of what you mention next 18 months there is a wall of refinancing in CRE that doesn't look very promising in terms of outcomes. the real question mark is what credit or economic event (those mtm on regional banks holding of 10 year notes must have gotten worse....) will make the FED pivot