Source: Golden Ten Data
The Federal Reserve will hold a meeting this week, and even if interest rates don't change, this meeting could be important.
After raising the key federal funds rate target by 5.25 percentage points over the past year and a half, the Federal Open Market Committee (FOMC) will almost certainly maintain its key interest rate range of 5.25% to 5.5% on Thursday. Most commentators have been concerned about whether it is possible to raise interest rates by another 25 basis points before the end of the year, as the FOMC's recent summary of economic forecasts (SEP) suggests.
But that probably misses the real point --The Fed's policy direction for 2024 and beyond. According to John Ryding, chief economic adviser to Brean Capital,How high will the interest rate rise and what is more important is how long will the interest rate remain at its peak level. Ryding is a long-time observer of the Federal Reserve and has worked for the Federal Reserve and the Bank of England.
SEP materials have undergone major changes
According to the recent SEP, the Fed will raise the federal funds rate by another 25 basis points by the end of this year, forecast a median value of 5.6%, and remain close to this level for a long time. By contrast, according to the CME FedWatch tool, the federal funds futures market expects an interest rate hike before the end of the year to be around 40%, while the probability of standing still is around 60%.
Judging from interest rate cut expectations, SEP's median forecast shows that the Fed will cut interest rates by 1 percentage point to 4.6% by the end of 2024. However, predictions surrounding this “consensus” range widely, ranging from 4.4% to 5.1%. In contrast, the federal funds futures market expects interest rates to reach 4.58% in December 2024, which is close to the median forecast of the Federal Reserve.
The latest SEP forecast was released on June 14, and the updated SEP will be announced at the end of this week's two-day FOMC meeting. Given that the economy is performing better than expected by the Federal Reserve, this should meanThere will be some major changes to the June SEP.
Bank of America economists expectReal gross domestic product (GDP) growth rate forecast for the fourth quarter of 2023It will be raised from 1% to 2%; expectedUnemployment rate at year endIt will be revised from 4.1% to 3.8%, which is consistent with the August data. As for inflation, Bank of America economists believe recent data is causingFourth quarter core PCE deflator forecastIt fell to 3.7%, and the June estimate was 3.9%. Basically, these numbers will all be adjusted based on recent data.
Are interest rate cut predictions too optimistic?
As mentioned, the most important news will be the FOMC's current outlook for 2024. In addition to the federal funds futures market, many economists also think that the Fed will cut interest rates at that time. A popular view is that if inflation falls as predicted by the FOMC, then failure to cut interest rates in time will lead to “passive” and possibly unintentional austerity brought about by rising real interest rates (adjusted for inflation). The June SEP predicts that the Fed's favorite inflation indicator, the core PCE, will slow significantly to 2.6% next year, entering the Fed's long-term target range of 2%.
However, Ryding said in an interview that it is expectedInterest rate cuts of 25 basis points four times next year “may be a bit too much”. The Federal Reserve has paid a high price to reduce inflation and has performed well so far. It would be easier for monetary authorities to keep interest rates constant and wait for interest rate cuts when needed.
He added,The last thing policymakers want is to lower interest rates too soon and then raise interest rates againThis is the old path taken by the Federal Reserve in the 70s of the last century.Cutting interest rates too soon may also pose a risk of financial instability, particularly if they trigger a rebound in risky assets, thereby easing the financial situation excessively.
Barron's pointed out that for investors, what they should focus on is the FOMC's outlook for 2024, not 2023. Chris Krueger (Chris Krueger), head of TD Cowen Washington Research Group, also warned in a client report last week that after this week's meeting, if the federal government shutdown blocks subsequent economic data release, the FOMC may “lose sight of both eyes” at the October 31 to November 1 meeting. More importantly,The premise for cutting interest rates next year is that inflation continues to slow down.But today's sharp rise in crude oil prices could affect other costs, as several airlines warned last week.
Although the era of ultra-low interest rates is over, the US economy continues to ignore recession predictions. All of this shows thatThe FOMC is likely to keep interest rates high for a longer period of time.
An overlooked focus — neutral interest rates
The debate over whether the Fed will maintain high interest rates for how long,Another overlooked focus is the long-term equalization of real federal funds interest rates(Economists call this “R*,” or “R-star”). After deducting an assumed long-term inflation rate of 2%, the FOMC basically assumes R* is 0.5%.
However, whether R* is still 0.5% as assumed by the Federal Reserve remains open to debate. After all, this level of interest rate, which neither boosts nor stifles the economy, cannot be observed in real time.
Ryding wanted to know why the Fed's estimate was still 0.5% when the market estimated R* had risen to around 2%.
I think one of the reasons for the rise in R* is the huge federal budget deficit. He said Macroeconomics 101 believes that fiscal expansion will raise R* unless the Fed allows additional borrowing.
However, the Federal Reserve is now doing the opposite, reducing its holdings of treasury bonds and institutional mortgage-backed securities (MBS) to allow the private sector to provide more financing for the federal government's massive borrowings. All else being equal, this should mean a higher level of interest rates.
Ryding said,This is a long-term issue that the Fed must begin to resolve, but he added that this is unlikely to happen at next week's meeting.