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Tag: tightening

  • Hate to spoil the party but there’s a new risk in town — a ‘no landing’ economy

    Hate to spoil the party but there’s a new risk in town — a ‘no landing’ economy

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    For the last 18 months, all you’ve heard from the markets is that the U.S. economy is three months away from a recession. Now, the popular analysis is that that inflation is on a smooth glidepath down and the economy will never have a downturn again.

    Worries about a recession have evaporated, and all the talk is about a “soft landing,” with the Federal Reserve not having to hike interest rates more than once more, at most.

    But behind the scenes, in some economic circles, there is growing concern about another risk for the economy, dubbed a “no landing” scenario.

    What does “no landing” mean? Essentially it’s marked by economic growth that’s too strong to allow inflation to fall all the way to 2%, where the Federal Reserve aims for it to be, and therefore an economy that will need more Fed rate hikes, according to Chris Low, chief economist at FHN Financial.

    So instead of the U.S. central bank starting to cut rates early next year, there may be more rate hikes in store.

    “There is still considerable work to do before the inflation beast is fully tamed,” Low said.

    Former Fed Vice Chair Richard Clarida described the risk in crystal-clear terms. “If the Fed finds itself  in March 2024 with an unemployment rate of 4% and an inflation rate of 4% with some of that temporary good news behind them, they are in a very tough spot,” Clarida said in a recent interview with Bloomberg News.

    “It is a risk. It is not the base case. But if I was still there [at the Fed], I would be assessing it,” he added.

    So why does this matter? Why would the Fed be in such a tough spot? Two words: presidential election.

    A Fed that is dedicated to bringing inflation down might have to slam the brakes on the economy forcefully to get the job done. That gets tough during an election year, especially one that already seems poised to be filled with acrimony.

    “The Fed does not play politics with monetary policy. The FOMC will do what is right for the economy, election year or not. Nevertheless, FOMC participants are already sensitive to triggering a recession. Doing it in an overt way when Congress, a third of the Senate, and the White House are up for grabs would be reckless,” Low said.

    Andrew Levin, professor of economics at Dartmouth College and a former top Fed staffer, said “raising interest rates sharply in the midst of an election cycle could be a delicate matter. Even the vaunted inflation fighter, Paul Volcker [the Fed’s chairman from 1979 to 1987], decided to ease off the brakes midway through the 1980 presidential campaign.”

    Ray Fair, a Yale economics professor, thinks that, whether or not the Fed successfully lowers consumer-price inflation to the vicinity of 2% will be what really matters for the 2024 presidential election. If inflation does not go gently and the Fed is still fighting next year, it would likely be negative for President Joe Biden and the Democratic Party, he said.

    See: Inflation could rebound later this year. And that might be a good thing.

    To avoid hiking rates next year, the Fed, in Low’s view, will raise interest rates to 6% by the end of this year. That is an out-of-consensus call. Financial markets think the Fed is done hiking with its benchmark policy interest rate in a range of 5.25% to 5.5%.

    Many economist and the financial markets are talking more about prospective Fed rate cuts in early 2024 than any more hikes.

    Asked during a recent radio interview if he thought a “no landing” scenario was taking shape, Philadelphia Fed President Patrick Harker replied: “I don’t think so.”

    Harker said the economy was likely on track to return to the low-interest-rate and low-inflation environment of 2012-19.

    “I think about this a lot, and I asked myself what’s different fundamentally about the U.S. economy now then the way it was before the pandemic,” Harker said. He concluded that there wasn’t much difference.

    The big trend Harker mentioned was demographics, with baby boomers still moving in large numbers into retirement. “I don’t think we have to stay in a high-inflation regime. I think we can get back to where we were,” he said.

    Steve Blitz, chief U.S. economist at research firm GlobalData.TSLombard, said he puts the probability of a “no landing” scenario at about 35%.

    Blitz added it was a common mistake for economists, policy makers, traders and journalists “to presume that the expansion to come is going to look like the expansion that was.”

    “At least in the United States, that was never the case,” he added.

    Blitz said that if the U.S. economy were growing at a rate below 2% with an inflation rate higher than 3%, the Fed would have to raise the policy rate to about 6.5%. But if the economy is humming along with 3% growth and inflation over 3%, that would be a trickier spot. “Does the Fed really want to slow that down?” he asked.

    See: The U.S. economy is aiming for a three-peat: 2% GDP growth

    The range of possible outcomes for the economy remains wide. Some economists still believe that a recession early next is the most likely outcome.

    Other economists, like Michelle Meyer, chief U.S. economist at Mastercard, think the economy will continue to grow, with inflation coming down. Meyer described that outcome as “a soft landing with bumps.”

    Stephen Stanley, chief economist at Santander U.S., said he thinks the U.S. economy will “muddle through” next year with subpar growth in the range of 1% for several quarters and inflation slowing gradually.

    “Obviously, that optimism melts away if we’re back to readings of 0.4% and 0.5% on core CPI in three months or six months,” Stanley said.

    Economic calendar: See what’s on the U.S. economic-data docket in the coming week

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  • The Fed will either pause or hike interest rates by 25 basis points. What are the pros and cons of each approach?

    The Fed will either pause or hike interest rates by 25 basis points. What are the pros and cons of each approach?

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    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.

    The Fed’s decision will come on Wednesday at 2 p.m. Eastern and will be followed by a press conference from Fed Chair Jerome Powell.

    “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.

    Stocks
    DJIA,
    +1.20%

    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.

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  • Another jumbo Fed rate hike is expected this week — and then life gets difficult for Powell

    Another jumbo Fed rate hike is expected this week — and then life gets difficult for Powell

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    First the easy part.

    Economists widely expect Federal Reserve monetary-policy makers to approve a fourth straight jumbo interest-rate rise at its meeting this week. A hike of three-quarters of a percentage point would bring the central bank’s benchmark rate to a level of 3.75%- 4%.

    “The November decision is a lock. Well, I would be floored if they didn’t go 75 basis points,” said Jonathan Pingle, chief U.S. economist at UBS.

    The Fed decision will come at 2 p.m. on Wednesday after two days of talks among members of the Federal Open Market Committee.

    What happens at Fed Chairman Jerome Powell’s press conference a half-hour later will be more fraught.

    The focus will be on whether Powell gives a signal to the market about plans for a smaller rise in its benchmark interest rate in December.

    The Fed’s “dot plot” projection of interest rates, released in September, already penciled in a slowdown to a half-point rate hike in December, followed by a quarter-point hike early in 2023.

    The market is expecting signals about a change in policy, and many think Powell will use his press conference to hint that a slower pace of interest-rate rises is indeed coming.

    A Wall Street Journal story last week reported that some Fed officials are not keen to keep hiking rates by 75 basis points per meeting. That, alongside San Francisco Fed President Mary Daly’s comment that the Fed needs to start talking about slowing down the pace of hikes, were taken as a sign of a slowdown to come by the stock and bond markets.

    “No one wants to be late for the pivot party, so the hint was enough,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics.

    Luke Tilley, chief economist at Wilmington Trust, said he thinks Powell will signal a smaller rate hike in December by focusing on some of the good wage-inflation news that was published earlier Friday.

    There was a clear slowdown in private-sector wage growth, Tilley said.

    See: U.S. third-quarter wage pressures cool a little from elevated levels

    But the problem with Powell signaling he has found an exit ramp from the jumbo rate hikes this year is that his committee members might not be ready to signal a downshift, Pingle of UBS said. He argued that the inflation data writ large in September won’t give Fed officials any confidence that a cooling in price pressures is in the offing.

    See: U.S. inflation still running hot, key PCE price gauge shows

    Another worry for Powell is that future data might not cooperate.

    There are two employment reports and two consumer-price-inflation reports before the next Fed policy meeting on Dec. 13–14.

    So Powell might have to reverse course.

    “If you pre-commit and the data slaps you in the head — then you can’t follow through,” said Stephen Stanley, chief economist at Amherst Pierpont Securities.

    This has been the Fed’s pattern all year, Stanley noted. It was only in March that the Fed thought its terminal rate, or the peak benchmark rate, wouldn’t rise above 3%.

    While the Fed may want to slow down the pace of rate hikes, it doesn’t want the market to take a downshift in the size of rate rises as a signal that a rate cut is in the offing. But some analysts believe that the first cut in fact will come soon after the Fed reduces the size of its rate rises.

    In general terms, the Fed wants financial conditions to stay restrictive in order to squeeze the life out of inflation.

    Pingle said he expects Kansas City Fed President Esther George to formally dissent in favor of a slower pace of rate hikes.

    There is growing disagreement among economists about the “peak” or “terminal rate” of this hiking cycle. The Fed has penciled in a terminal rate in the range of 4.5%–4.75%. Some economists think the terminal rate could be lower than that. Others think that rates will go above 5%.

    Those who think the Fed will stop short of 5% tend to talk about a recession, with the fast pace of Fed hikes “breaking something.” Those who see rates above 5% think that inflation will be much more persistent.

    Ultimately, Amherst Pierpont’s Stanley is of the view that the data aren’t going to be the deciding factor. “The answer to the question of what either forces or allows the Fed to stop is probably not going to come from the data. The answer is going to be that the Fed has a number in mind to pause,” he said.

    The Fed “is careening toward this moment of truth where it has very tight labor markets and very high inflation, and the Fed is going to come out and say, ‘OK, we’re ready to pause here.’ “

    “That strikes me that is going to be a very volatile period for the market,” he added.

    Fed fund futures markets are already volatile, with traders penciling in a terminal rate above 5% two weeks ago and now seeing a 4.85% terminal rate.

    Over the month of October, the yield on the 10-year Treasury note
    TMUBMUSD10Y,
    4.046%
    rose steadily above 4.2% before softening to 4% in recent days.

    “When you get close to the end, every move really counts,” Stanley said.

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  • Another jumbo Fed rate hike is expected this week — and then life gets difficult for Powell

    Another jumbo Fed rate hike is expected this week — and then life gets difficult for Powell

    [ad_1]

    First the easy part.

    Economists widely expect Federal Reserve monetary-policy makers to approve a fourth straight jumbo interest-rate rise at its meeting this week. A hike of three-quarters of a percentage point would bring the central bank’s benchmark rate to a level of 3.75%- 4%.

    “The November decision is a lock. Well, I would be floored if they didn’t go 75 basis points,” said Jonathan Pingle, chief U.S. economist at UBS.

    The Fed decision will come at 2 p.m. on Wednesday after two days of talks among members of the Federal Open Market Committee.

    What happens at Fed Chairman Jerome Powell’s press conference a half-hour later will be more fraught.

    The focus will be on whether Powell gives a signal to the market about plans for a smaller rise in its benchmark interest rate in December.

    The Fed’s “dot plot” projection of interest rates, released in September, already penciled in a slowdown to a half-point rate hike in December, followed by a quarter-point hike early in 2023.

    The market is expecting signals about a change in policy, and many think Powell will use his press conference to hint that a slower pace of interest-rate rises is indeed coming.

    A Wall Street Journal story last week reported that some Fed officials are not keen to keep hiking rates by 75 basis points per meeting. That, alongside San Francisco Fed President Mary Daly’s comment that the Fed needs to start talking about slowing down the pace of hikes, were taken as a sign of a slowdown to come by the stock and bond markets.

    “No one wants to be late for the pivot party, so the hint was enough,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics.

    Luke Tilley, chief economist at Wilmington Trust, said he thinks Powell will signal a smaller rate hike in December by focusing on some of the good wage-inflation news that was published earlier Friday.

    There was a clear slowdown in private-sector wage growth, Tilley said.

    See: U.S. third-quarter wage pressures cool a little from elevated levels

    But the problem with Powell signaling he has found an exit ramp from the jumbo rate hikes this year is that his committee members might not be ready to signal a downshift, Pingle of UBS said. He argued that the inflation data writ large in September won’t give Fed officials any confidence that a cooling in price pressures is in the offing.

    See: U.S. inflation still running hot, key PCE price gauge shows

    Another worry for Powell is that future data might not cooperate.

    There are two employment reports and two consumer-price-inflation reports before the next Fed policy meeting on Dec. 13–14.

    So Powell might have to reverse course.

    “If you pre-commit and the data slaps you in the head — then you can’t follow through,” said Stephen Stanley, chief economist at Amherst Pierpont Securities.

    This has been the Fed’s pattern all year, Stanley noted. It was only in March that the Fed thought its terminal rate, or the peak benchmark rate, wouldn’t rise above 3%.

    While the Fed may want to slow down the pace of rate hikes, it doesn’t want the market to take a downshift in the size of rate rises as a signal that a rate cut is in the offing. But some analysts believe that the first cut in fact will come soon after the Fed reduces the size of its rate rises.

    In general terms, the Fed wants financial conditions to stay restrictive in order to squeeze the life out of inflation.

    Pingle said he expects Kansas City Fed President Esther George to formally dissent in favor of a slower pace of rate hikes.

    There is growing disagreement among economists about the “peak” or “terminal rate” of this hiking cycle. The Fed has penciled in a terminal rate in the range of 4.5%–4.75%. Some economists think the terminal rate could be lower than that. Others think that rates will go above 5%.

    Those who think the Fed will stop short of 5% tend to talk about a recession, with the fast pace of Fed hikes “breaking something.” Those who see rates above 5% think that inflation will be much more persistent.

    Ultimately, Amherst Pierpont’s Stanley is of the view that the data aren’t going to be the deciding factor. “The answer to the question of what either forces or allows the Fed to stop is probably not going to come from the data. The answer is going to be that the Fed has a number in mind to pause,” he said.

    The Fed “is careening toward this moment of truth where it has very tight labor markets and very high inflation, and the Fed is going to come out and say, ‘OK, we’re ready to pause here.’ “

    “That strikes me that is going to be a very volatile period for the market,” he added.

    Fed fund futures markets are already volatile, with traders penciling in a terminal rate above 5% two weeks ago and now seeing a 4.85% terminal rate.

    Over the month of October, the yield on the 10-year Treasury note
    TMUBMUSD10Y,
    4.030%
    rose steadily above 4.2% before softening to 4% in recent days.

    “When you get close to the end, every move really counts,” Stanley said.

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