Fed Meeting: How High Will Interest Rates Go and What Else to Expect at This Week’s Meeting.

Will “permanent” in the Federal Reserve go out? Or will that remain the key word in the central bank’s policy directive?

On such a seemingly trivial question, the course of interest rates may depend when the Federal Open Market Committee announces the results of its two-day meeting next Wednesday afternoon.

The Fed’s policy-setting panel is all but certain to raise its federal-funds target range to 4.50%-4.75%. That would represent a downshift to a 25-basis-point hike, the FOMC’s usual rate move until last year, when it played to normalize its monetary policy, which was previously uber-easy. The committee imposed four supersize 75-basis-point hikes in 2022 and then added a 50-basis-point hike in December. (A basis point is 1/100th of a percentage point.)

At the time, the FOMC stated that it “anticipates that the ongoing increases in the target range will be appropriate.” Keeping the plural word “increases” in his policy statement would imply at least two more 25-basis-point hikes, most likely at the March 21-22 and May 2-3 confabs. That would raise the Fed funds target range to 5%-5.25%, matching the median 5.1% single-point forecast in the FOMC’s most recent summary of economic projections, released at the December meeting.

But the market does not believe that. As the chart here shows, the Fed funds futures market is only one more increase at the March meeting. And after keeping his rate target at 4.75%-5%, the market currently expects a 25 basis point cut the day after Halloween, back to 4.50%-4.75%. That would put the key policy rate about half a point below the FOMC’s median year-end projection, and below 17 of the 19 committee members’ forecasts.

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The Treasury is also fighting the Fed. The two-year note, the maturity most sensitive to rate expectations, traded Friday at a 4.215% yield, below the lower end of the current 4.25%-4.50% target range. The peak of the Treasury yield curve is at six months, where T-bills trade at 4.823%. From there, the curve slopes lower, with the benchmark 10-year note at 3.523%. Such a configuration is a classic signal that the market anticipates lower interest rates.

A slew of Fed spokesmen in recent weeks have spoken favorably of slowing the pace of rate hikes, pointing to a 25-basis-point hike Wednesday. But they all stuck to the message that monetary policy remains the course to get inflation back to the central bank’s target of 2%.

Based on the latest reading of the central bank’s favored inflation measure, the personal consumption expenditure deflator, it is too early to say that policy is restrictive enough to achieve that goal, argue John Ryding and Conrad DeQuadros, the veteran Fed watcher at Brain Capital. The data released Friday showed the PCE deflator up 5.0%, year over year. So, even after the possible Fed funds increase this coming week, to a 4.50%-4.75% target range, the key rate would still be negative when adjusted for inflation, indicating that Fed policy remains easy.

Brean Capital economists expect Fed Chairman Jerome Powell to reiterate that the central bank will not repeat the mistake of the 1970s when it eased policy too quickly, allowing inflation to accelerate. Recent measures of inflation have slipped below the four-decade highs touched last year, largely due to easing prices for energy and goods including used cars, which rose during the pandemic.

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But Powell emphasized non-housing core service prices as key indicators of future price trends. The increase in non-residential service prices is seen to be mainly driven by labor costs. Powell emphasized the tightness of the labor market, which is reflected in a historically low unemployment rate of 3.5% and new claims for unemployment insurance below 200,000.

But in what BCA Research called an important speech, Fed Vice President Lael Brainard noted that non-housing service costs rose more strongly than labor costs, as measured by the Employment Cost Index.

If so, one can assume that these measures of inflation will resolve faster than the ECI, perhaps as a result of narrowing profit margins. In any case, a reading on the fourth quarter ECI will be released on Monday, one day before the members of the Federal Open Market Committee meet.

Brainard, who has emphasized the lag between Fed actions and their impact on the economy, was reported by the Washington Post last week to be on a shortlist to replace Brian Deese as head of the National Economic Council. If she leaves for the White House, it would be a key vote to moderate the pace of monetary policy.

At the same time, while the Fed funds rate has moved closer to restrictive levels, overall financial conditions have eased. This is reflected in the decline in long-term borrowing costs, such as mortgages; Corporate credit, especially in the high-yield market, which has rallied in recent weeks; Stock prices, rising from their October lows; Volatility, which is strongly withdrawn for equities and fixed income; and the slide in the dollar, a big boon for exporters.

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In any case, if the FOMC’s statement speaks of “permanent” rate hikes, that will serve as a clue to the central bank’s thoughts on future rates. Alternatively, the statement could emphasize that politics is becoming data-dependent.

If so, economic releases, such as Friday morning’s jobs report and subsequent inflation readings, will be even more import. A further delay in nonfarm payroll growth, to 185,000 in January from December 223,000 is the consensus call of economists. The December Jobs Openings and Labor Turnover Survey, or JOLTS, release comes Wednesday morning, just in time for the FOMC to consider.

Powell’s postmeeting press conference will also send important signals. He is sure to be asked if working conditions remain tight after the flurry of job cuts from tech companies. And he is certain of the wide gulf between what the market sees for rates and what is predicted in the Fed’s December summary of economic projections, which will not be updated until March.

All that is certain is that the debate about monetary policy will continue.

Write to Randall W. Forsyth at [email protected]


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