At upcoming policy meetings in November and maybe December, the Federal Reserve is expected to suggest a pause in its aggressive interest rate rising campaign. The move comes after a sharp increase in Treasury bond yields over the past few weeks, which has tightened financial conditions and helped the Fed out.
During his speech to the Economic Club of New York on Thursday, Fed Chairman Jerome Powell clearly implied a hold. Powell indicated that the economy is showing signs of exhibiting reducing inflationary pressures, but he did not commit to the policy route ahead.
Aside from the lags in the impact of monetary policy, he also mentioned ongoing geopolitical uncertainty as grounds for the Fed to “proceed carefully.”
The markets saw Powell’s comments as ruling out the possibility of further significant rate hikes. After the speech, CME Group’s FedWatch predicted a 98% chance of a hold decision in November. After four consecutive 0.75 percentage point increases, this would bring the fed funds rate target range to 5.25-5.50%.
In a later question-and-answer session with Bloomberg TV’s David Westin, the Fed chair acknowledged the role of rising bond yields. Investors responded strongly to Powell’s remarks, sending the yield on 10-year Treasuries soaring to above 5% by Thursday evening. This was the highest level since 2007.
Treasury rates across the curve have been rising this week on rising inflation and GDP worries. The cost of corporate bonds and house mortgages go up when long-term interest rates rise. Without further intervention from the Fed, this dynamic tightens overall financial conditions.
The market’s anticipation of further Fed hikes or concerns over expanding fiscal deficits are two of the explanations Powell mentioned for the abrupt increase in yields. However, he seemed to infer that forces apart than the trajectory of monetary policy are acting as major catalysts at the moment.
“It doesn’t seem to be principally about expectations of us doing more,” said Powell. “For now, it’s clearly a tightening in financial conditions.”
There have been hints from some Fed members that the bond market is effectively tightening in their stead. In early October, San Francisco Federal Reserve President Mary Daly said the effect of the yield hikes thus far was equivalent to “about a rate hike.” The yields have increased much more since then.
Powell agreed with this sentiment, stating that increased interest rates are “how monetary policy works.” The increases will discourage lending and investment, which will dampen inflation and growth.
Powell did not endorse a particular yield level, but he did suggest that if yields continue to rise, further raises from the Fed might not be necessary. He agreed that it “at the margin, could” lessen the temptation to raise rates further.
The markets also don’t expect a Fed rate cut anytime soon. Powell indicated emphatically that despite rising recessionary risks, current policy is not unduly tight. This furthers the belief that any respite will be temporary, rather than a switch to easing.
The Fed’s next move following the months of November and December will depend on the information they get. In his remarks, Powell emphasized that lowering inflation remains a major concern.
However, experts believe the Fed is content to let bond market dynamics play out for the time being. In December, the Fed will release its Summary of Economic Projections, where rate forecasts may be revised downward.
According to Peter Williams, an economist at 22V Research, “there is little sign or desire that the Fed wants to start discussing [rate] cuts.” “Monetary policy will remain biased towards firming in the medium-term.”
Given that inflation remains much above the Federal Reserve’s 2% goal, it’s unlikely that they will declare triumph just yet. However, if yields keep going up, it becomes less likely that there will be any more massive rate hikes in 2023.