Federal Reserve Chairman Jerome Powell has been clear that the American central bank is fighting a two-part inflation battle. The first question revolves around how high interest rates will go. Then comes the concern about how long they will be held.
1. Will officials eventually acknowledge they are done raising interest rates?
Officials don’t need to look hard for reasons that might lead them to remain silent about whether they have truly finished raising interest rates – and whether they are discussing the timing of future rate cuts.
The significant tightening of financial conditions last fall, which pushed mortgage rates above 8 percent and the yield on 10-year Treasury bonds above 5 percent, has reversed quickly. Since peaking on October 19, the yield on 10-year Treasury bonds has dropped by 86 basis points, helping to lower the 30-year mortgage rate to 7.23 percent, its lowest level since August, according to Bankrate data.
In hopes that the Fed can achieve a soft landing in its attempt to cool inflation, the S&P 500 surpassed its yearly high on December 1. According to the CME Group’s FedWatch tool, investors are pricing in a rate cut by March 2024.
The risk in easing financial conditions is that it could spark inflation or further asset price gains if it goes unchecked. For instance, housing activity is affected by interest rates. With the rapid decline in mortgage rates, refinance applications in the week ending December 1 were the strongest in two months, while applications surpassed last year’s levels for two consecutive weeks for the first time since late 2021, according to data from the Mortgage Bankers Association.
“Markets are not just expecting that the Fed has finished raising rates, but they are anticipating that the Fed will begin cutting rates,” says McBride. “At the same time, the Fed does not want to acknowledge that it has finished raising rates yet. If markets can move significantly without the Fed saying it has finished raising rates, what happens when it actually does?”
In the minutes of the Fed’s November meeting, officials acknowledged that they were likely in a position where they could “proceed cautiously” and might be able to monitor incoming data in the “coming months” to determine if more action is needed.
However, Powell reiterated in his recent speech before officials entered their blackout period to prepare for their December 12-13 meeting to set interest rates that if the Fed takes any action regarding rates, it is likely to be upward – not downward.
2. How will the Fed keep markets from getting ahead of itself?
The one thing that cannot be ignored is that officials still have one more interest rate hike recorded in the Summary of Economic Projections (SEP) updated in September. In the chart known as the “dot plot,” officials marked a top target range of 5.5-5.75 percent for the federal funds rate.
But this additional interest rate hike may be part of a signaling game toward tightening policy, according to Vincent Reinhart, chief economist and macro strategist at Dreyfus and Mellon and former secretary and economist for the Open Market Committee.
Officials are set to wrap up the year with another update to their interest rate forecasts. Reinhart says their forecasts are likely to be lowered for 2023 since the Fed did not follow through with this rate hike. However, he also sees officials possibly signaling a reduction in the number of rate cuts for 2024 to prevent markets from getting ahead of themselves.
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Their last update in September recorded officials only 50 basis points of price cuts for next year.
“This is how to protest against market pricing in a rapidly changing environment,” says Reinhart. “The Federal Reserve is ready to make the final phase difficult. That’s why it needs to keep the political interest rate steady for some time.”
3. What will the Federal Reserve look for when determining when to cut interest rates?
Officials at the Federal Reserve have noted that they would be willing to cut interest rates before inflation officially reaches 2 percent.
“We will maintain a restrictive policy until we are confident that inflation is on a sustainable path to 2 percent,” Powell said to reporters after the Federal Reserve meeting in September.
Important in the discussion about interest rates is the “real cost” of money – that is, interest rates minus inflation. The Federal Reserve’s prime borrowing rate has been above the overall inflation rate since May, indicating that policy is officially in a restrictive stance. The lower inflation goes, and as long as rates remain at the current level of 5.25-5.5 percent, the more monetary policy will take momentum away from the U.S. economy.
“There are two ways to cut interest rates,” says Reinhart. “The chaotic way is a response to data telling you that you need to quickly lower the real cost of money. The other way is the way you want to do it every time, which is to follow inflation down.” Cutting prices is like candy to investors, who always seem to crave it. But the reasons behind these calls have changed over time. When the Federal Reserve first began raising interest rates, market participants were worried about a repeat of history. They priced in rate cuts by December 2023, assuming that Federal Reserve officials might spark a deep recession just as they did in the 1980s when Federal Reserve Chair Paul Volcker tried to curb the lingering inflation.
Conclusion
Consumers hoping to mitigate the impact of high-interest rates on their wallets will want to pay down variable-rate debts and high-interest credit cards. Such debts are likely to remain unattainable at cheaper rates anytime soon, while credit card rates are hovering at all-time highs, according to Bankrate data.
At the same time, uncertainty surrounding the economy underscores the importance of saving any amount you can for emergencies. Putting your money in a high-yield savings account can help you build your emergency fund faster – and maintain your purchasing power against rising inflation. All bank accounts recommended by Bankrate currently offer returns that exceed the overall inflation rate.
If you already have at least six months of expenses saved and are looking to diversify your portfolio with more risk-free investments, it’s a good time to lock in a long-term certificate of deposit. These offerings are unlikely to get better than they are now, according to McBride.
“We’ve seen this movie three or four times, where markets exceed their expectations significantly, and Powell has to show tough talk and bring investors back to reality,” says McBride. “The Federal Reserve raised interest rates higher than markets were anticipating, so it’s likely they won’t cut rates as quickly as markets expect.”
Source: https://www.aol.com/december-fed-meeting-preview-3-051049408.html
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