Receive free updates on the US economy with our myFT Daily Digest email. Stay informed on the latest news and developments in the US economy every morning. Welcome! I’m Ethan, and Rob will be back next week. Yesterday, Jennifer Hughes’ letter titled “You don’t remember rising rates” sparked a response from several notable readers who do remember. For those of us currently experiencing it, the Federal Reserve has raised interest rates to the highest level in two decades. Read on for more details. If you have any questions or comments, feel free to email me at [email protected].
The Fed:
Yesterday’s expected 25 basis point rate increase lacked new information from Fed chair Jay Powell. The pre-presser statement saw one significant change: the growth description was upgraded from “modest” to “moderate.” Market reaction was predictably uneventful. The two-year yield, which is sensitive to policy changes, barely moved. The S&P 500 initially rose but ultimately ended the trading day where it started.
Powell’s message was clear, though echoed previous sentiments. The Fed’s primary concern is reducing inflation and is willing to accept negative effects on employment if necessary. The Fed wants to see consistent declines in inflation data that clearly indicate a convergence towards the 2% target rate. While the labor market has made progress, it remains imbalanced with demand outweighing supply. The Fed believes this will keep core services inflation, excluding housing, elevated.
When asked about future rate path, Powell remained noncommittal, stating that anything is possible. The data-dependent Fed will make careful decisions on a meeting-by-meeting basis and communicate when it has a clear understanding, making no promises or secrets. Powell also downplayed recent financial conditions easing, noting that markets tend to align eventually.
Interesting points arose when Powell addressed the cooler June consumer price index and its impact on a potential soft landing. One would expect a data-dependent Fed to respond positively to such encouraging data. However, Powell regarded it as just one report for a single month. This stance is surprising because excluding shelter and used cars, inflation has decreased significantly. This holds true for the Fed’s concerning non-housing services inflation, which is approaching or surpassing pre-pandemic levels.
Powell is aware of these trends. His caution highlights the central bank’s priorities. Failing to contain inflation in the same cycle as the Fed’s mistaken belief in transitory inflation would have devastating consequences. A mild recession, on the other hand, would not be as severe. Therefore, despite encouraging signs of decreasing inflation without a sharp decline in growth, the Fed will continue its current course. Here’s Powell’s take:
“The overall resilience of the economy, the fact that we’ve been able to achieve disinflation so far without any meaningful negative impact on the labor market [is] a good thing… At the margins, stronger growth could lead over time to higher inflation and that would require an appropriate response for monetary policy… What we see are those pieces of the [disinflationary] puzzle coming together and we’re seeing evidence of those things now. But I would say what our eyes are telling us is policy has not been restrictive enough for long enough to have its full desired effects… We think the process still probably has a long way to go.”
Powell acknowledges the possibility of robust growth reigniting inflation. Another risk arises from falling inflation, which boosts purchasing power and sustains consumer spending, leading to increased hiring and a tight labor market. The extent to which current inflation stems from elevated demand is unclear.
Is the Fed done raising rates? Futures market pricing suggests a higher probability that it is finished, and many finance experts share this view. Their argument relies on ongoing trends of cooling core inflation and a slower labor market. Paul Ashworth from Capital Economics states:
“We suspect that further signs of a significant easing in the monthly core CPI numbers for July and August will ultimately persuade the Fed to hold fire for the remainder of this year, particularly if, as we expect, employment gains continue to trend lower too.”
This perspective makes sense under the assumption that the data supports it. However, consider the counterargument. Economic data during this cycle has been volatile. If the July and August data is mixed, rather than indicating rapid disinflation, the Fed’s inclination will likely be to nudge rates higher. Our regular correspondent, Ed Al-Hussainy, expects one more 25 basis point rate increase, framing it as the Fed aligning with its June economic projections rather than it significantly impacting the inflation outlook.
Don’t rule out the possibility of another rate increase at the next meeting. If the data remains inconclusive, the Fed’s incentive is to push rates higher.
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