Fed Chair Jerome Powell at yesterday’s press conference. Photo: Alex Wong/Getty Images
On Wednesday afternoon, the Federal Reserve raised interest rates for the ninth time in a row in the face of a banking crisis. It also confirmed that its plans for the year remain more or less intact and that almost all of its executives expect at least one more rate hike.
- But investors don’t buy it – not even a little bit.
Why it matters: Financial markets are essentially betting that events will overtake the central bank’s best plans and that banking problems will tighten credit conditions enough to slow growth significantly in the coming months.
Driving the news: At Wednesday’s monetary policy meeting, the Fed raised interest rates by a quarter point while adding a few options to its future plans. The committee noted that the banking situation is likely to weigh on the economy and that “some” additional policy tightening “may” be needed – a retreat from earlier language that was more committed.
- In new forecasts, 17 out of 18 Fed policymakers expect another rate hike by the end of the year (with the only outlier expected to keep rates steady).
The Intrigue: The markets, on the other hand, consider significant interest rate cuts to be almost certain. As of Thursday morning, futures market prices calculated by the CME FedWatch tool implied only about a 2% chance that the Fed’s target rate at the end of the year will be the same or higher.
- Similarly, Treasury markets have moved in ways that overwhelmingly suggest imminent rate cuts, even after Powell insisted at his press conference that “rate cuts are not in our base case.”
- As of Thursday morning, two-year Treasuries were yielding 3.92%, almost a full percentage point below the Fed’s short-term interest rate target.
Between the lines: The Fed decided to tighten further, feeling that the economic impact of the banking problems, while likely negative, is highly uncertain.
- What is certain, however, is that inflation is too high and the labor market remains very tight – which means the Fed must do more to bring inflation down.
- In fact, Powell’s message was that the Fed would only switch to lighter money if there was unequivocal evidence of a slowdown, which would bring inflation. The mere risk that banking turmoil could be triggered is not enough to change course.
- But markets are implicitly betting that that is exactly what will happen – that tensions in banks will cause them to pull back their loans, leading to a recession that in turn depresses inflation.
Part of the jump the bond yields that took place during Powell’s press conference on Wednesday weren’t about anything he said. Treasury Secretary Janet Yellen testified on Capitol Hill at the same time, throwing cold water at the idea of perpetual guarantees on all bank deposits.
- But this juxtaposition proves the point further.
The bottom line: Right now, the Fed’s stated plans for monetary policy and the level of market concern about the banks are at odds – and the overall economic outlook depends on which is right.
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