After holding interest rates steady at 5.25% to 5.5% the Federal Reserve continues to outline potential scenarios for even higher rates. Fed Chair Jerome Powell stated at the November 1 post-meeting press conference, “The question we are asking is should we hike more?”
However, markets disagree, believing the economy is likely at peak rates already for this cycle. As such, there may be a disconnect between the move dovish assessment of markets, and somewhat hawkish language from the Fed.
Fixed income futures markets currently see a 1 in 4 chance that rates move higher at one of the Fed’s next two decisions on December 13 or January 31 according to the CME’s FedWatch Tool. The market’s base case is that we are now at peak rates, and as we move later into 2024, rate cuts become more likely than rate hikes on current estimates. Yet Powell was clear in his the post-meeting press conference that “the committee is not thinking about rate cuts at all.”
The Fed’s Perspective
The Fed still argues rates could go higher. The opening comments of Powell’s press conference referenced “the extent of additional policy firming,” suggesting that higher rates are far more likely than lower rates in the near term. Also, when questioned, Powell avoided taking a December interest rate hike off the table. It was also notable that November’s meeting decision was unanimous, meaning no Fed policymaker voted for a rate hike.
The Economic Data
Economic data has not yet suggested that the Fed’s work on inflation is done. The Fed’s target is an annual rate of 2% when current inflation is closer to 4% on most metrics for the latest September reports. Fed leaders believe they are “making progress” on inflation. For example, Personal Consumption Expenditures price index inflation (excluding food and energy) for September 2023 came in at a 3.7% annual rate. That’s arguably the Fed’s preferred metric for assessing inflation.
Elsewhere, the U.S. labor market appears to be cooling, but remains robust. There is wage inflation that may continue to put pressure on services prices. The housing market, too, isn’t quite following the traditional script for higher rates. Despite mortgage rates of around 8%, home prices haven’t fallen much and indeed have rebounded since spring 2023. Of course, there are expectations that home prices will ultimately decline.
Importantly, in recent weeks, yields on the 10-year bonds have approached 5%. The Fed argues that the recent move up in longer-term interest rates has done some of its tightening work for it. That may be one reason why the Fed elects to avoid another hike in 2023. Still there are economic risks, too, such as potentially rising energy prices, various strike activity and some risk of a government shutdown.
The Fed Versus The Market
During this interest-rate cycle, the Fed’s forecasts have largely won out over the perspective of fixed income markets. However, if there isn’t another rate increase in 2023, that balance may change. In September, Fed policymakers typically saw one more interest rate hike coming in 2023. Markets have always been more skeptical of that, when compared to the Fed’s assessment, and they may ultimately be correct.
What’s Next?
Despite the focus on whether or not the Fed moves interest rates up again, they are expected to remain at high levels for much of 2024. If current forecasts hold, it’s unlikely rates will fall below 4% in 2024. Both the Fed and markets expect rates to remain restrictive for some time, even if there’s disagreement on whether we see another hike in the near term.
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