Federal Reserve officials, meeting days after the collapse of Silicon Valley Bank, agreed that the stress in the banking sector would slow U.S. economic growth, but were uncertain about how much, according to minutes of the meeting released Wednesday.
The twelve voting members on the Fed’s interest-rate committee “agree that recent developments were likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring and inflation, but that the extend of these effects were…
In the wake of the collapse of Silicon Valley Bank, conventional wisdom has been that banks will cut lending, known as a credit crunch, that will damage the economy.
On Thursday, St. Louis Federal Reserve President James Bullard said he was “less enamored’ with this forecast.
“Only about 20% of lending is going through the banking system…
The numbers: U.S. private payrolls climbed by 145,000 in March, according to the ADP National Economic report released on Wednesday.
Economists polled by The Wall Street Journal had forecast a gain of 210,000 private sector jobs.
The private sector added a revised 261, 000 jobs in January.
Key details: Service sector providers added 75,000 jobs in March. Leisure and hospitality added 98,000 workers. Meanwhile, goods producers added 70,000 jobs. Manufacturing shed 30,000 jobs.
By company size, small businesses added 101,000 private-sector jobs in March while medium businesses added 33,000. Large-sized businesses added 10,000 jobs.
Pay growth decelerated for both job stayers and job changers, ADP said.
For job stayers, year-over-year gains fell to 6.9% from 7.2%. For job changers, pay growth was 14.2%, down from 14.4%.
Big picture: The job market has been strong, with jobless claims trending below 200,000. Companies seem wary of letting workers go.
Economists are forecasting that the U.S. Labor Department’s employment report will show the economy added 238,000 jobs in March. That estimate includes government jobs. If the data comes in as expected, it could show over one million jobs created in the first three months of the year.
What ADP said: “Our March payroll data is one of several signals that the economy is slowing,” said Nela Richardson, chief economist, ADP. “Employers are pulling back from a year of strong hiring and pay growth, after a three-month plateau, is inching down.”
SPX, -0.25%
were set to open lower after the data. The yield on the 10-year Treasury note TMUBMUSD10Y, 3.282%
fell to 3.32% after the data was released.
The spike in oil prices after the surprise OPEC+ production cut may make the Federal Reserve’s inflation-fighting job “a little more difficult,” but it is too soon to know for sure, said St Louis Fed President James Bullard, on Monday. “This was a surprise – this OPEC decision – but whether it will have a lasting impact, I think, is an open question,” Bullard said, in an interview on Bloomberg Television. “Oil prices fluctuate around – it is hard to track exactly. Some of that might feed into inflation and make our job a little more difficult,” he added. Bullard said he had already expected higher oil prices due to the recent upgrades to the economic outlook for both China and Europe. The St. Louis Fed president thinks the Fed should raise rates to a range of 5.5%-5.75%. That’s higher than the median Fed forecast of 5%-5.25%. “I think inflation will be stickier,” he said, noting that the Dallas trimmed mean price index, which excludes each month’s volatile components of inflation, was 4.6% in February, unchanged from the prior month.
The Federal Reserve will meet on Wednesday and, for once, the outcome is unclear.
This is the most uncertain Fed meeting since 2008, said Jim Bianco, president of Bianco Research.
Fed officials, starting with former chair Ben Bernanke, have perfected the art of having the market price in what the central bank will do — at least regarding interest rates — at each upcoming meeting. That has happened 100% of the time, Bianco said on Twitter.
The Fed’s meeting this week is different because it follows the sudden collapse of confidence in the U.S. banking system following the government takeover of Silicon Valley Bank as well as the tremors around the world that have led to the shotgun wedding of Swiss banking giant Credit Suisse and its longtime rival, UBS.
At the moment, the market probabilities are 73% for a quarter-percentage-point move and 27% for no move, according to the CME FedWatch tool. The market seems to be growing in confidence of a hike, analysts said, based on movements on the front end of the curve.
“Depending on your perspective, the Fed’s decision will be seen as either capitulation to the markets or ivory-tower isolation from the markets,” said Ian Katz, a financial sector analyst with Capital Alpha Partners.
Here are the pros and cons for both a pause and a 25-basis-point hike.
The case for and against a pause
The main rationale for a pause is that the banking system is under stress.
“While policymakers have responded aggressively to shore up the financial system, markets appear to be less than fully convinced that efforts to support small and midsize banks will prove sufficient. We think Fed officials will therefore share our view that stress in the banking system remains the most immediate concern for now,” said Jan Hatzius, chief economist at Goldman Sachs, in a note to clients Monday morning.
Former New York Fed President William Dudley said he would recommend a pause. “The case for zero is ‘do no harm,’” he said.
The case against a pause is that it could spark more worries about the banking system.
“I think if they pause, they are going to have to explain exactly what they are seeing, what is giving them more concern. I am not sure a pause is comforting,” said former Fed Vice Chair Roger Ferguson in a television interview on Monday
The case for and against a 25-basis-point hike
The main reason for a quarter-percentage-point rate increase, to a range of 4.75%-5%, is that it could project confidence.
“What you need from policymakers is steady hands, steady ship,” said Max Kettner, chief multi-asset strategist at HSBC. “You don’t need overaction … flip-flopping around in projections or opinions.”
The Fed should say that it has managed to contain confidence so far and that “we can press ahead with the inflation fight,” he added.
Oren Klachkin, lead U.S. economist at Oxford Economics, said he didn’t think “the recent bank failures pose systemic risks to the broad financial system and economy.”
He noted that “inflation is still running hot” and the Fed has better ways to alleviate banking-sector stress than interest rates.
The case against hiking is that doing so could further exacerbate concerns about the stability of the banking sector.
“A rate hike now might have to be quickly reversed to deal with a deeper, less contained recession and disinflation. Why would the Fed raise rates when it may be forced to cut rates so much sooner than previously hoped?” asked Diane Swonk, chief economist at KPMG.
Gregory Daco, chief economist at EY, said he thinks economic activity is slowing, which gives the Fed time.
“There is no rush to hike. We are not going to see hyperinflation as a result,” he said.
SPX, +0.89%
rose Monday. The yield on the 10-year Treasury note TMUBMUSD10Y, 3.485%
inched up to 3.46%, still well below the 4% level seen prior to the banking crisis.
Rising Treasury yields appeared Tuesday to finally catch up with a previously resilient stock market, putting major indexes on track for their worst day so far of 2023.
“Yields are popping across the curve, with the 2-year back to its November highs. This time it seems, market rates are playing catch up with fed funds,” said veteran technical analyst Mark Arbeter, president of Arbeter Investments, in a note.
Since the beginning of the month, traders in fed-funds futures have priced in a more aggressive Federal Reserve after initially doubting the central bank would hit its forecast for a peak fed-funds rate above 5%. A few traders are even pricing in the outside possibility of a peak rate near 6%.
Arbeter noted that markets generally lead fed-funds higher, not the other way around. Meanwhile, the U.S. dollar has also rallied, with the ICE U.S. Dollar Index adding 0.2% to a February bounce.
Arbeter also noted that breadth indicators, a measure of how many stocks are participating in a rally, had previously deteriorated, with some measures reaching oversold levels.
“Just another perfect storm against the equity markets in the short term,” he wrote.
Rising yields can be a negative for stocks, increasing borrowing costs. More important, higher Treasury yields mean that the present value of future profits and cash flow are discounted more heavily. That can weigh heavily on tech and other so-called growth stocks whose valuations are based on earnings far into the future. Those stocks were pummeled heavily last year but have led gains in an early 2023 rally, remaining resilient through last week even as yields extended a bounce.
Yields have been on the rise after a run of hotter-than-expected economic data, which have boosted expectations for Fed rate hikes. Weak guidance Tuesday from Home Depot Inc. HD, -7.09%
and Walmart Inc. WMT, +0.59%
also contributed to the tone.
Home Depot sank 6.5%, and was the biggest lower on the Dow Jones Industrial Average DJIA, -2.06%,
after the home-improvement retailer reported a surprise decline in fiscal fourth-quarter same-store sales, guided for a surprise drop in fiscal 2023 profit and earmarked an additional $1 billion to pay its associates more.
“While Wall Street expects resilient consumers following last week’s robust retail sales report, Home Depot and Walmart are much more cautious,” said Jose Torres, senior economist at Interactive Brokers, in a note.
“This morning’s data offers more mixed signals concerning consumer demand, but during a traditionally weak seasonal trading period, investors are shifting toward a glass half-empty view against the backdrop of a year that’s featured the exact opposite so far, a glass half-full perspective,” he wrote.
The Dow remained down nearly 650 points, or 1.9%, while the S&P 500 SPX, -2.00%
slumped 1.9% to trade at 4,001 after earlier dipping below the 4,000 level for the first time since Jan. 25. The S&P 500 was on track for its biggest daily drop since December. The Nasdaq Composite COMP, -2.50%
was down 2.4%.
The losses left the Dow clinging to a 0.1% year-to-date gain, while the S&P 500 remains up more than 4% and the Nasdaq Composite has rallied over almost 10% so far this year.
Arbeter identified a “very interesting cluster” of support just below the Tuesday low for the S&P 500, with the convergence of a pair of trend lines along with the index’s 50- and 200-day moving averages all near 3,970 (see chart below).
Arbeter Investments LLC
“If that zone does not represent the pullback lows, we have more trouble ahead,” he wrote.
The Federal Reserve and investors appear to be locked in what one veteran market watcher has described as an epic game of “chicken.” What Fed Chair Jerome Powell says Wednesday could determine the winner.
Here’s the conflict. Fed policy makers have steadily insisted that the fed-funds rate, now at 4.25% to 4.5%, must rise above 5% and, importantly, stay there as the central bank attempts to bring inflation back to its 2% target. Fed-funds futures, however, show money-market traders aren’t fully convinced the rate will top 5%. Perhaps more galling to Fed officials, traders expect the central bank to deliver cuts by year-end.
Stock-market investors have also bought into the latter policy “pivot” scenario, fueling a January surge for beaten down technology and growth stocks, which are particularly interest rate-sensitive. Treasury bonds have rallied, pulling down yields across the curve. And the U.S. dollar has weakened.
Cruisin’ for a bruisin’?
To some market watchers, investors now appear way too big for their breeches. They expect Powell to attempt to take them down a peg or two.
How so? Look for Powell to be “unambiguously hawkish,” when he holds a news conference following the conclusion of the Fed’s two-day policy meeting on Wednesday, said Jose Torres, senior economist at Interactive Brokers, in a phone interview.
“Hawkish” is market lingo used to describe a central banker sounding tough on inflation and less worried about economic growth.
In Powell’s case, that would likely mean emphasizing that the labor market remains significantly out of balance, calling for a significant reduction in job openings that will require monetary policy to remain restrictive for a long period, Torres said.
If Powell sounds sufficiently hawkish, “financial conditions will tighten up quickly,” Torres said, in a phone interview. Treasury yields “would rise, tech would drop and the dollar would rise after a message like that.” If not, then expect the tech and Treasury rally to continue and the dollar to get softer.
Hanging loose
Indeed, it’s a loosening of financial conditions that’s seen trying Powell’s patience. Looser conditions are represented by a tightening of credit spreads, lower borrowing costs, and higher stock prices that contribute to speculative activity and increased risk taking, which helps fuel inflation. It also helps weaken the dollar, contributes to inflation through higher import costs, Torres said, noting that indexes measuring financial conditions have fallen for 14 straight weeks.
The Chicago Fed’s National Financial Conditions Index provides a weekly update on U.S. financial conditions. Positive values have been historically associated with tighter-than-average financial conditions, while negative values have been historically associated with looser-than-average financial conditions.
Federal Reserve Bank of Chicago, fred.stlouisfed.org
Powell and the Fed have certainly expressed concerns about the potential for loose financial conditions to undercut their inflation-fighting efforts.
The minutes of the Fed’s December meeting. released in early January, contained this attention-grabbing line: “Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.”
That was taken by some investors as a sign that the Fed wasn’t eager to see a sustained stock market rally and might even be inclined to punish financial markets if conditions loosened too far.
If that interpretation is correct, it underlines the notion that the Fed “put” — the central bank’s seemingly longstanding willingness to respond to a plunging market with a loosening of policy — is largely kaput.
The tech-heavy Nasdaq Composite logged its fourth straight weekly rise last week, up 4.3% to end Friday at its highest since Sept. 14. The S&P 500 SPX, +0.25%
advanced 2.5% to log its highest settlement since Dec. 2, and the Dow Jones Industrial Average DJIA, +0.08%
rose 1.8%.
Meanwhile, the Fed is almost universally expected to deliver a 25 basis point rate increase on Wednesday. That is a downshift from the series of outsize 75 and 50 basis point hikes it delivered over the course of 2022.
Data showing U.S. inflation continues to slow after peaking at a roughly four-decade high last summer alongside expectations for a much weaker, and potentially recessionary, economy in 2023 have stoked bets the Fed won’t be as aggressive as advertised. But a pickup in gasoline and food prices could make for a bounce in January inflation readings, he said, which would give Powell another cudgel to beat back market expectations for easier policy in future meetings.
Jackson Hole redux
Torres sees the setup heading into this week’s Fed meeting as similar to the run-up to Powell’s speech at an annual central banking symposium in Jackson Hole, Wyoming, last August, in which he delivered a blunt message that the fight against inflation meant economic pain ahead. That spelled doom for what proved to be another of 2023’s many bear-market rallies, starting a slide that took stocks to their lows for the year in October.
But some question how frustrated policy makers really are with the current backdrop.
Sure, financial conditions have loosened in recent weeks, but they remain far tighter than they were a year ago before the Fed embarked on its aggressive tightening campaign, said Kelsey Berro, portfolio manager at J.P. Morgan Asset Management, in a phone interview.
“So from a holistic perspective, the Fed feels they are getting policy more restrictive,” she said, as evidenced, for example, by the significant rise in mortgage rates over the past year.
Still, it’s likely the Fed’s message this week will continue to emphasize that the recent slowing in inflation isn’t enough to declare victory and that further hikes are in the pipeline, Berro said.
Too soon for a shift
For investors and traders, the focus will be on whether Powell continues to emphasize that the biggest risk is the Fed doing too little on the inflation front or shifts to a message that acknowledges the possibility the Fed could overdo it and sink the economy, Berro said.
She expects Powell to eventually deliver that message, but this week’s news conference is probably too early. The Fed won’t update the so-called dot plot, a compilation of forecasts by individual policy makers, or its staff economic forecasts until its March meeting.
That could prove to be a disappointment for investors hoping for a decisive showdown this week.
“Unfortunately, this is the kind of meeting that could end up being anticlimactic,” Berro said.
The Federal Reserve and investors appear to be locked in what one veteran market watcher has described as an epic game of “chicken.” What Fed Chair Jerome Powell says Wednesday could determine the winner.
Here’s the conflict. Fed policy makers have steadily insisted that the fed-funds rate, now at 4.25% to 4.5%, must rise above 5% and, importantly, stay there as the central bank attempts to bring inflation back to its 2% target. Fed-funds futures, however, show money-market traders aren’t fully convinced the rate will top 5%. Perhaps more galling to Fed officials, traders expect the central bank to deliver cuts by year-end.
Stock-market investors have also bought into the latter policy “pivot” scenario, fueling a January surge for beaten down technology and growth stocks, which are particularly interest rate-sensitive. Treasury bonds have rallied, pulling down yields across the curve. And the U.S. dollar has weakened.
Cruisin’ for a bruisin’?
To some market watchers, investors now appear way too big for their breeches. They expect Powell to attempt to take them down a peg or two.
How so? Look for Powell to be “unambiguously hawkish,” when he holds a news conference following the conclusion of the Fed’s two-day policy meeting on Wednesday, said Jose Torres, senior economist at Interactive Brokers, in a phone interview.
“Hawkish” is market lingo used to describe a central banker sounding tough on inflation and less worried about economic growth.
In Powell’s case, that would likely mean emphasizing that the labor market remains significantly out of balance, calling for a significant reduction in job openings that will require monetary policy to remain restrictive for a long period, Torres said.
If Powell sounds sufficiently hawkish, “financial conditions will tighten up quickly,” Torres said, in a phone interview. Treasury yields “would rise, tech would drop and the dollar would rise after a message like that.” If not, then expect the tech and Treasury rally to continue and the dollar to get softer.
Hanging loose
Indeed, it’s a loosening of financial conditions that’s seen trying Powell’s patience. Looser conditions are represented by a tightening of credit spreads, lower borrowing costs, and higher stock prices that contribute to speculative activity and increased risk taking, which helps fuel inflation. It also helps weaken the dollar, contributes to inflation through higher import costs, Torres said, noting that indexes measuring financial conditions have fallen for 14 straight weeks.
The Chicago Fed’s National Financial Conditions Index provides a weekly update on U.S. financial conditions. Positive values have been historically associated with tighter-than-average financial conditions, while negative values have been historically associated with looser-than-average financial conditions.
Federal Reserve Bank of Chicago, fred.stlouisfed.org
Powell and the Fed have certainly expressed concerns about the potential for loose financial conditions to undercut their inflation-fighting efforts.
The minutes of the Fed’s December meeting. released in early January, contained this attention-grabbing line: “Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.”
That was taken by some investors as a sign that the Fed wasn’t eager to see a sustained stock market rally and might even be inclined to punish financial markets if conditions loosened too far.
If that interpretation is correct, it underlines the notion that the Fed “put” — the central bank’s seemingly longstanding willingness to respond to a plunging market with a loosening of policy — is largely kaput.
The tech-heavy Nasdaq Composite logged its fourth straight weekly rise last week, up 4.3% to end Friday at its highest since Sept. 14. The S&P 500 SPX, +0.25%
advanced 2.5% to log its highest settlement since Dec. 2, and the Dow Jones Industrial Average DJIA, +0.08%
rose 1.8%.
Meanwhile, the Fed is almost universally expected to deliver a 25 basis point rate increase on Wednesday. That is a downshift from the series of outsize 75 and 50 basis point hikes it delivered over the course of 2022.
Data showing U.S. inflation continues to slow after peaking at a roughly four-decade high last summer alongside expectations for a much weaker, and potentially recessionary, economy in 2023 have stoked bets the Fed won’t be as aggressive as advertised. But a pickup in gasoline and food prices could make for a bounce in January inflation readings, he said, which would give Powell another cudgel to beat back market expectations for easier policy in future meetings.
Jackson Hole redux
Torres sees the setup heading into this week’s Fed meeting as similar to the run-up to Powell’s speech at an annual central banking symposium in Jackson Hole, Wyoming, last August, in which he delivered a blunt message that the fight against inflation meant economic pain ahead. That spelled doom for what proved to be another of 2023’s many bear-market rallies, starting a slide that took stocks to their lows for the year in October.
But some question how frustrated policy makers really are with the current backdrop.
Sure, financial conditions have loosened in recent weeks, but they remain far tighter than they were a year ago before the Fed embarked on its aggressive tightening campaign, said Kelsey Berro, portfolio manager at J.P. Morgan Asset Management, in a phone interview.
“So from a holistic perspective, the Fed feels they are getting policy more restrictive,” she said, as evidenced, for example, by the significant rise in mortgage rates over the past year.
Still, it’s likely the Fed’s message this week will continue to emphasize that the recent slowing in inflation isn’t enough to declare victory and that further hikes are in the pipeline, Berro said.
Too soon for a shift
For investors and traders, the focus will be on whether Powell continues to emphasize that the biggest risk is the Fed doing too little on the inflation front or shifts to a message that acknowledges the possibility the Fed could overdo it and sink the economy, Berro said.
She expects Powell to eventually deliver that message, but this week’s news conference is probably too early. The Fed won’t update the so-called dot plot, a compilation of forecasts by individual policy makers, or its staff economic forecasts until its March meeting.
That could prove to be a disappointment for investors hoping for a decisive showdown this week.
“Unfortunately, this is the kind of meeting that could end up being anticlimactic,” Berro said.
The numbers: U.S. consumer sentiment improved in late January to 64.9, according to the University of Michigan’s gauge of consumer attitudes.
This added 5.2 index points from 59.7 in December and was up from the initial January reading of 64.6.
Economists surveyed by The Wall Street Journal had forecast an unchanged reading of 64.6.
Key details: A gauge of consumer’s views of current conditions rose to a final reading of 68.4 in January from 59.4 in the prior month.
The indicator of expectations for the next six months rose to 62.7 from 59.9 in December.
Americans viewed that inflation was moderating in January. They expected the inflation rate in the next year to average about 3.9%, down from 4.4% in December. This is the lowest level since April 2021.
In the longer run, inflation expectations held steady at 2.9%.
Big picture: Consumer confidence rose for the second straight month on lower energy prices and better financial market conditions. Assessments of personal finances are improving, supported by higher income and easing price pressures.
But sentiment remains well below the pre-pandemic level of 101 hit in February 2020 and the more recent high of 88.3 hit in April 2021.
The U.S. Treasury Department began taking “extraordinary measures” on Thursday to keep the federal government current on its bills, while giving Congress more time to come up with a debt ceiling deal.
Those special measures allow the Treasury to keep paying its bills, including paying holders of government debt what they are due, while also, for now, continuing the issuance of bills and notes as scheduled in the near $24 trillion Treasury market, the world’s biggest debt market, to replace maturing debt.
“There’s constant maturities and constant new issuance,” said Jim Vogel, an interest-rate strategist at FHN Financial, in an interview Thursday. “Until the Treasury calls a halt to auctions they go on as normal.”
In part, new note auctions on deck will replace maturing bonds issued years ago, which should help give confidence to investors that the U.S. government intends to fully repay principal and interest, as promised. It also helps bide time for Congress to strike a deal to increase or suspend the existing debt limit.
“Your early warning system is when 6-month bills get cheaper,” Vogel said, adding that a wobble in that part of the Treasury market could signal worries by investors that top lawmakers could fail to reach a debt ceiling deal by this summer, which could then raise the threat level of a U.S. government default.
What’s next in the U.S. debt limit standoff
The U.S. debt limit was first set in 1917, and already has been increased or suspended 102 times since World War II, according to David Kelly, chief global strategist at JP Morgan Funds, in a recent client note.
The government had been approaching its current debt limit of $31.385 trillion, prompting Treasury Secretary Janet Yellen on Thursday to deploy special measures to keep the government current on its bills, including making payments to bondholders, in moves she outlined a week ago.
Kelly said the Treasury has leeway to make adjustments to postpone “our real rendezvous with disaster” potentially until June, but that from an economic and financial perspective a U.S. default would be “an unmitigated disaster.”
Tax payments due to the U.S. government from corporations and households this spring also factor into the bigger debt-limit picture, while also influencing the final deadline for Congress to avoid an default on America’s debt.
“We are coming up to the March corporate tax day,” said Steven Ricchiuto, U.S. chief economist at Mizuho Securities, by phone Thursday. “That could boost the Treasury’s balances,” he said, while also noting the influx from taxes last was higher than anticipated.
Why investors are focusing on the debt ceiling now
With the ultimate showdown likely months away there are no discernible ripples in financial markets right now, but investors and analysts do seem to be paying much closer attention to the threat at a much earlier date than in past episodes, market watchers said.
Blame the intraparty battle between House Republicans that saw Kevin McCarthy elected speaker on Jan. 7 after a historic 15 ballots – and only after agreeing to a series of concessions to a small group of far-right conservatives.
Investors are “talking about it early because it came on the heels of a very difficult election of the speaker of the House and the sense that there’s now much more leverage that a few members of Congress may have to force this crisis that’s more likely to hit later in the summer,” said Christopher Smart, chief global strategist at Barings and head of the Barings Investment Institute, in a phone interview.
Some recent history underscores the concern. It took all of then-Speaker John Boehner’s political capital – “and then some” – to finally secure a vote among the Republican caucus on raising the debt limit during a similar showdown in 2011, Smart noted, observing that Boehner had “much more leeway” than McCarthy.
“So if there are five or more members who won’t vote” on raising the limit “without certain conditions being met,” it’s easy to imagine potentially ugly scenarios that could rattle markets, he said.
What’s at stake
Former Federal Reserve Bank of New York President Bill Dudley said Thursday in an interview with Bloomberg that a U.S. default would be a “huge blow” to markets, but also that a contingency plan exits if it happens.
“The way it works is if you actually run out of money, the Treasury will decide what payments to present to the Fed,” Dudley said. “Presumably, the Treasury will decide to prioritize debt repayment and interest payments, so there isn’t a technical default. The Fed will basically honor the payments the Treasury present.”
The Fed also could step in to shore up market functioning in the Treasury market, if needed.
“What we saw in 2011 is that the Treasury market got stronger until we got close to the deadline,” Dudley said. “People don’t want to buy Treasury bills that are maturing right around the time the debt limit could be binding.”
As a result of a 2011 debt-ceiling standoff, credit rating firm Standard & Poor’s downgraded the U.S. credit ratings to AA from AAA.
U.S. stocks declined for a third straight day on Thursday, with the Dow Jones Industrial Average DJIA, -0.76%
losing 252.40 points, or 0.8%, while the S&P 500 SPX, -0.76%
shed 0.8% and the Nasdaq Composite Index COMP, -0.96%
dropped 1%.
The Federal Reserve is likely to raise interest rates more than the markets now expect, says Ricardo Reis, an economist at the London School of Economics.
“Markets are going to get rocked,” Reis told MarketWatch on the sidelines of the American Economic Association annual meeting in New Orleans.
“All the risks are on the upside. A rate of 5.5% is the minimum,” he added.
Last month the Fed raised the top end of its benchmark rate range to 4.5%. The central bank penciled in a 5.25% terminal rate.
Investors who trade in the fed-funds futures market now expect the Fed to stop raising when rates get to 5%.
Reis thinks the central bank will ultimately move rates higher.
The Fed is burned by failing to recognize the persistent upward move of inflation in 2021, he said.
“So I think they are biased toward over-tightening,” he said. “Either legitimately or because they are worried about fixing their past mistake, there are going to be tighter than you think.”
The economy is at a turning point and the Fed does face some “tough calls,” Reis said.
The key going forward is the path of wages.
Workers need to have their wages go up because their paychecks have not kept up with inflation.
So the Fed is going to have to gauge if the rise in wages is too much, just right or too little, he said.
If wages don’t rise much, inflation can quickly return to the Fed’s 2% target, he said.
If wages rise in line with productivity, the Fed won’t have to raise too much and inflation will come down to 2% in a few years.
This will be difficult because productivity is an economic variable that is hard to measure.
If wages spike, this would probably cause companies to continue raising prices, kicking off a wage-price spiral, Reis warned.
The Fed might overreact to the rise in wages, he said.
There is a scenario where rates go up “much more,” Reis said. But there is a range — it could be “much much more” or “much more” or “just more.”
Reis said that he was sympathetic to the idea that raising the unemployment rate to 5.5% was not a terrible outcome if it means a return to low inflation.
SPX, +2.28%
moved sharply higher Friday when the government reported relatively slow increase in wages in December. The yield on the 10-year Treasury note TMUBMUSD10Y, 3.562%
fell to 3.56%.
None of the 19 top Federal Reserve officials expect it will be appropriate to cut interest rates this year, according to the minutes of the central bank’s December policy meeting, which were released Wednesday.
Fed officials welcomed recent inflation data that showed reductions in the monthly pace of price increases but wanted to see a lot more evidence of progress to be convinced inflation was on a sustained downward path, the minutes indicated.
Investors who trade in the federal funds futures market expect the Fed to start reducing interest rates this summer.
Fed officials said that if markets start to ease financial conditions, especially if driven by a misperception of how the Fed was responding to the data, that “would complicate” the Fed effort to restore price stability.
Officials downshifted to a 50-basis-point rate increase at the Dec. 13-14 meeting, after four straight moves of 75 basis points. That puts their benchmark rate in a range between 4.25% to 4.5%. A number of Fed officials said it was important to stress that raising rates at a slower pace was not a sign of any “weakening” in the Fed’s resolve to bring inflation down to 2% or a judgement that inflation was already on a downward path.
Seventeen of 19 Fed officials said they expected rates to rise above 5% this year. Officials penciled in the high end of the interest-rate range at 5.25%, with seven officials penciling in even higher rates.
This is well above market-based measures of Fed policy-rate expectations.
Earlier on Wednesday. Minneapolis Fed President Neel Kashkari said he would like to see the Fed hike interest rates to 5.4% before pausing.
Investors see the high end of the Fed’s interest-rate range hitting 5.25% this summer and then retreating.
Fed officials said upside risks to inflation remained a “key factor” in shaping policy.
The market expects the Fed to downshift to a 25-basis-point hike at their next meeting, slated for Jan. 31- Feb.1.
Officials said they are trying to balance two risks — doing too little and adding fuel to inflation and raising rates too high and and lead to an “unnecessary reduction” in economic activity.
The number: U.S. wholesale prices rose 0.3% in November, the Labor Department said Friday.
Economists polled by The Wall Street Journal has forecast a 0.2% gain.
This is the third straight 0.3% monthly gain in the PPI index. Inflation in October and September was also revised up from the prior estimate of a 0.2% gain.
The core producer price index, which excludes volatile food, energy and trade prices, also rose 0.3% in November, up from a 0.2% gain in the prior month.
The increase in producer prices over the past 12 months slowed to 7.4% gain from 8.1% in the prior month. This is down from the peak of 11.7% in March.
Over the past year, core prices rose 4.9%, down from 5.4% in October.
Key details: The cost of energy fell 3.3% in November after a 2.3% gain in the prior month.
Food prices jumped 3.3% after a 0.8% increase in the prior month.
The cost of trade services jumped 0.7% in November after two straight monthly declines.
Big picture: Although hotter than expected in November, inflation at the wholesale level is showing steady deceleration from the peak in March.
The market is more focused on consumer price inflation report, which will be released next Tuesday, one day before the Fed’s decision on interest rates.
Market reaction: Stock futures DJIA, -0.25%
turned lower on the upside surprise to the monthly gain. The yield on the 10-year Treasury note TMUBMUSD10Y, 3.533%
jumped to 3.5%.
The numbers: U.S. pending home sales fell 4.6% in October, the fifth straight monthly decline, the National Association of Realtors said Wednesday.
Economists polled by the Wall Street Journal expected pending home sales to fall 5.5%.
The index captures transactions where a contract has been signed, but the home sale has not yet closed.
Key details: On a year-on-year basis, pending home sales were down a sharp 37%.
Sales fell in three of the four regions, with the Midwest registering an increase.
Big picture: Sales have stalled as mortgage rates have jumped, making houses less affordable. Pending home sales are a leading indicator for the sector. Some economists think that buyers might return to the market as mortgage rates have plateaued.
Economists polled by The Wall Street Journal had expected a 0.4% fall.
This is the eighth straight decline in the leading index.
The long period of declines suggests “the economy is possibly in a recession,” said Ataman Ozyildirim, senior director of economic research at the Conference Board. He said the data show a recession is likely to start around the end of the year and last through mid-2023.
The coincident index, which measures current conditions, rose 0.2% in October after a 0.1% gain in the prior month. The lagging index increased by 0.1%, matching the September gain.
The LEI is a weighted gauge of 10 indicators designed to signal business-cycle peaks and valleys.
The numbers: Existing-home sales fell 5.9% to a seasonally adjusted annual rate of 4.43 million in October, the National Association of Realtors said Friday. Compared with October 2021, home sales were down 28.4%.
Economists polled by the Wall Street Journal had expected an decrease to 4.37 million units.
The level of sales is the lowest since December 2011 excluding the 2020 pandemic.
This is also the ninth straight monthly decline in sales, the longest streak on record.
Key details: The median price for an existing home was $379,100 up 6.6% from October 2021.
But price gains are decelerating. Prices were up over 20% on a year-on-year basis earlier this year.
Housing inventory fell 0.8% to 1.22 million units in October. Unsold inventory sits at a 3.3-month supply at the current sales pace, up from 3.1 months in September and 2.4 months a year ago.
A 6-month supply of homes is generally viewed as indicative of a balanced market.
Sales declined in all regions of the country.
Big picture: Home sales have dropped as mortgage rates have risen sharply and affordability has dropped.
Softer inflation data in October have led to a drop in mortgage rates, which could lead for a floor on sales.
At the same time, Federal Reserve officials may pencil in a “peak” interest rate above 5% at the policy meeting next month.
Economists see home prices have further to fall in this market.
What the NAR is saying: Home sales have been very low and the softness could continue for a few months. But sales could pick up early next year if the mortgage rate has peaked, said Lawrence Yun, chief economist at the NAR.
Economists polled by the Wall Street Journal had expected manufacturing to rise to 51.8 in October and for the service sector to rise to 49.7.
Key details: In the service sector, the downturn was fueled by the rising cost of living and tightening financial conditions.
New orders in the manufacturing sector fell back into contraction territory in October. Output remained resilient due to firms eating into backlogs of previously placed orders, S&P Global said.
While price pressures picked up a bit in the service sector, the pace of the gain in inflation in the manufacturing sector was the slowest in almost two years.
Big picture: Talk of a recession sometime in 2023 has picked up in the last week. Many economists are sounding more bearish on the outlook, especially since the Federal Reserve is now seen raising its benchmark rate to 5%. However, on Monday, economists at Goldman Sachs said that talk over a recession was overblown.
What S&P Global said: “The US economic downturn gathered significant momentum in October, while confidence in the outlook also deteriorated sharply,” said Chris Williamson, chief business economist at S&P Global Market Intelligence.
“Although price pressures picked up slightly in the service sector due to high food, energy and staff costs, as well as rising borrowing costs, increased competitive forces meant average prices charged for services grew at only a fractionally faster rate. Combined with the easing of price pressures in the goods-producing sector, this adds to evidence that consumer price inflation should cool in coming months,” he added.
