Evening Brief – 10.19.23
Hawkish, Dovish, Neutral
The health of the US economy and ongoing tight labor markets may warrant further interest rate hikes, Fed Chair Jerome Powell said on Thursday in a speech at the Economic Club of New York, defying market expectations that the US central bank’s policy tightening has ended.
In view of rising long-term bond yields, which may hamper economic growth, Powell suggested the Fed may hold interest rates steady next month. But he also stated that if the economy and labor market continue to heat up, the Fed may raise rates again.
“Financial conditions have tightened significantly in recent months, and longer-term bond yields have been an important driving factor in this tightening,” Powell said. “We remain attentive to these developments because persistent changes in financial conditions can have implications for the path of monetary policy.”
The 10-year US Treasury yield has risen from 3.2% in March to 4.996% as of Thursday, its highest level in 16 years, given a stronger-than-expected economy, which could push inflation higher, and a significant increase in the supply of Treasuries connected to aggressive fiscal spending.
“In any case, inflation is still too high, and a few months of good data are only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal,” Powell said.
As a reminder, the Fed’s “dot-plots” still show one more 25 basis point hike in November or December.
Given the latest set of data that appears to heighten doubt about how much progress they are making on GDP, the job market, and inflation, Powell had to strike a comparatively more hawkish tone regarding a potential hike in December.
Markets are now aware that headline inflation remains stubbornly high at 3.7%, and that the Middle East war poses additional upside risk to inflation. Given the tight labor market, the bond market cannot predict when the Fed’s interest rate cycle will end.
But Powell also gave a nod to the dovish camp. “Doing too much could also do unnecessary harm to the economy… and “…indicators of wage growth show a gradual decline toward levels that would be consistent with 2 percent inflation over time.”
Some Fed speakers have been more dovish recently, providing hope for the equity bulls, despite rate-cut expectations for 2024 having plunged in recent days. Both Chicago Fed President Austan Goolsbee and Philadelphia Fed President Patrick Harker have stated that the central bank should stop raising interest rates.
And for those still on the fence, Powell said: “Given the uncertainties and risks, and how far we have come, the Committee is proceeding carefully. We will make decisions about the extent of additional policy firming and how long policy will remain restrictive based on the totality of the incoming data, the evolving outlook, and the balance of risks.”