Market pricing, verbal cues from Federal Reserve members and the likely evolution of the economic data over the next couple of months all point in the same direction — the central bank is likely done raising interest rates.
Forecasting the end of the Fed’s tightening cycle requires jumping the gun a bit. To the extent that officials ever declare rate increases are behind us, the message will only come once we have gotten through several no-change meetings. By then, we will perhaps be in an environment where economic weakness seems more likely than strong growth. But there are reasons to predict the policy turn with a fair degree of confidence now.
The first pointer comes from traders. Market-based odds of another move higher in 2023 have fallen since the September meeting to around 40% from 53%. The probability that officials hike rates on Nov. 1 is down to 12% from 31%. Barring the kind of shock that the Fed hates to deliver, we’re really talking about whether or not they tighten in December.
The shift in pricing follows commentary from Fed speakers that’s signaled a comfort with the current setting of policy, even as they retained a hawkish bias. Fed Governor Christopher Waller, who has been an important voice during this cycle, said on Wednesday that the central bank can “watch and see” before potentially acting again. Dallas Fed President Lorie Logan indicated that if risk premiums in the bond market are on the rise and weigh on economic activity, there could be “less need for additional monetary policy tightening.” The rise in longer-term interest rates — 10-year Treasury yields are up by around one percentage point since the start of June — could substitute for a final rate increase in the minds of officials, Nick Timiraos wrote in the Wall Street Journal.
It’s worth considering next what the state of play will be going into the Fed’s December meeting. October is already shaping up to be a rough month given the impact of the United Auto Workers strikes and the restart of student loan payments, with the economic data coming through in November as Fed officials begin signaling what they intend to do at their final meeting of the year. A government shutdown may well be on the table again by then. The combined impact has the potential to shave a percentage point off gross domestic product growth in the fourth quarter, Bloomberg Economics’ Anna Wong and Tom Orlik wrote recently.
Falling retail gasoline prices should also flow into the October consumer price inflation data, and shelter inflation should decelerate from September’s elevated pace, making both headline and core inflation appear soft.
With all this in the mix, it’s worth noting that the Fed has an easy out available. Its September summary of economic projections anticipated a 25-basis-point increase in the policy rate by the end of 2023, followed by 50 basis points of cuts in 2024. An obvious way to retain a hawkish stance without raising rates would be to remove those 2024 cuts from the December projections, affirming a “higher for longer” setting.
Beyond December, the inertia from multiple meetings of no policy change will set in. With the Fed’s framework shifting from “how high” to “how long,” officials could push projected rate cuts further into the future if there’s a need to re-emphasize tight monetary policy.
What’s noteworthy — and short-sighted — is how markets have accepted the likelihood of higher-for-longer rates at the start of a quarter when economic growth should decelerate from the heady pace of the previous three months, and the Fed appears to be done. Looking out a bit further, 2024 won’t see the same growth drivers that have fueled economic activity so far, whether it was the thawing of supply chains in industries such as automobile production or ongoing projects financed in the low-interest-rate environment.
Instead, companies are likely to feel more pain after enjoying relative insulation from the Fed’s policy moves because so much debt was termed out at low rates in 2020 and 2021. Fed Vice Chair Philip Jefferson told a conference on Monday that he would be “mindful of the additional tightening in train” as corporate debt is refinanced at higher rates next year.
It took longer to get to the end of the tightening cycle than most expected. Now that we’re here, I'm inclined to think that what comes next will more closely follow prior cycles. In three of the four rate-hike cycles since the mid-1990s, the Fed moved to lowering rates within eight months of its final increase, and in the fourth it took 15 months.
We don’t yet have a smoking gun — such as the subprime-mortgage or dot-com bubbles of previous recessions — but, as pent-up demand from the pandemic recedes into the past, it’s no longer easy to come up with areas of the economy likely to surprise either. History suggests that the gap between the end of a rate-hike cycle and the start of a rate-cut cycle rarely exceeds a year. With monetary policy tighter than it’s been in 15 years, I’m less inclined to bet against history.
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