Great expectations for the day after tomorrow, Wednesday 21 September, when Jerome Powell’s Fed will launch a new attack on US-made inflation, announcing the decision taken on fed funds rates.
On July 27, the Fed raised rates by 75 basis points, for the second consecutive time, confirming its fight against runaway inflation in the United States. On that occasion, with its second consecutive hike of 75 basis points, Powell & Co raised rates on US fed funds in the new range between 2.25% and 2.5%at the record since the end of 2018.
together, the monetary tightening of June and July on the part of the Fed represented the largest consecutive rate hikes since the Fed began using overnight rates as its primary monetary policy tool in the early 1990s. And it could be just the beginning. That of the day after tomorrow, therefore, risks being yet another increase of 75 basis points, for the third consecutive time.
But, evidently, it is still too little to push back the numbers on inflationwhich continue to be still too high, up to more than four times the inflation target set by the Federal Reserve, equal to 2%.
In particular, as highlighted by theUS consumer price index – among the most closely monitored parameters to predict the monetary policy moves of the American central bank – and in spite of the recent decline in energy prices and the gasoline sboom inflation made in the USA it continues to strengthen in some of its components (see core inflation). And, if it is true that it has weakened, headline inflation continues to march at a much faster pace than expected by the consensus.
The publication of the shock numbers had immediate effects on Wall Street, sunk by sales after the disclosure of the data: the repricing of the US terminal rates and someone has started betting even on a close of 100bps.
Not for nothing Goldman Sachs economists have revised upward their forecasts for what the Fed will announce the day after tomorrow: now they estimate a monetary tightening of 75 basis points, compared to the increase of 50 basis points previously expected.
“The (higher) rates, combined with the recent tightening of financial conditions, imply a somewhat worse outlook for next year (GDP) growth and employment,” Goldman Sachs economists added.
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So Joachim Fels, PIMCO’s Global Economic Advisor:
“Gone are the days when central banks only moved rates in 25 basis point increments. Last week, both the European Central Bank and the Bank of Canada raised policy rates by 75 basis points, following in the footsteps of the Federal Reserve with two hikes of 75 basis points in June and July. Also, after yet another surprise to the upside in US CPI inflation this week, the Fed looks set to continue tightening at this pace next week and possibly again in November and December. ”
And don’t finish that, since “Markets are pricing a greater than 50% probability that the Bank of England and the ECB’s next move is a 75 basis point hike rather than a 50 basis point. Why 75 basis points is the new normal at this stage of the tightening cycle. – continued Fels – It is obvious: in the face of continued and massive overshoots in inflation, central banks are focusing heavily on maintaining the anchoring of long-term inflation expectations. Currently, officials all seem to be guided by the old saying that only hawks go to central bankers’ paradise and are therefore determined, in Jerome Powell’s words, to ‘keep going until the job is done’.
“But how will central bankers and market participants know when the job will be done and it will be appropriate to take a break? “, wonders and asks the Pimco expert.
The answer is as follows:
“Given the uncertainty over the unobserved neutral interest rate level, officials made it clear that they wanted to see inflation on a sustained downward path, which I interpret as at least several months of declining core inflation. This downward path could remain unattainable for some time, especially in the United States, given the acceleration of wage increases, which are important drivers of service sector inflation, and the prospect of prolonged strong increases in the shelter component of the CPI “.
“It is not clear what the terminal level of rates needed to complete the job is, but the suspicion is that it is above the 4.25% spike for the Fed Funds rate that the markets are pricing right now. It is quite clear, however, that work cannot be painless “, as the Wall Street trend showed on the inflation shock day, that is, last Tuesday.
In short: “Financial markets will still have to suffer as financial conditions are the transmission mechanism of monetary policy, and this is likely to be imminent as central banks continue to raise rates and the Fed shrinks its balance sheets. To avoid a further acceleration in wages, the labor market needs to be penalized by rising unemployment, which is likely to occur soon in response to past and future tightening of financial conditions. Consequently, the proverbial soft landing that central bankers are hoping for and that the markets have been chasing in recent months seems to me rather unlikely “.
The US economy therefore appears destined for a hard landinghard landing, just the worst scenario so feared. Moreover, “despite a likely hard landing in the form of a recession in developed market economies, a quick central bank turn from a rate hike to a rate cut appears very unlikely unless there is a major financial crash or a massive attack of ‘clean disinflation’ out of thin air. Central bankers will want to avoid the mistakes of the stop-go policies of the 1970s, when their predecessors reversed course soon after inflation peaked, thus setting the stage for the next period of inflation to even higher peaks. elevated. A lasting stalemate in rates at higher levels therefore seems more likely than the Fed rate reversal which is priced in the forward curve for next year ”.
“This brings us to the last point, which we already highlighted in this year’s Secular Outlook – conclude Joachim Fels – Although the next recession is expected to be relatively small, given the absence of large imbalances in the private sector, it is unlikely to be followed by a V-shaped recovery as the viscosity of inflation will prevent central banks from easing monetary policy in a way significant in a short time. Furthermore, the safeguards for the financial markets will be less, as central banks will not come to the rescue as quickly and readily as they have in the past two decades. Winter is coming”.
A clear SOS of the markets has been launched in these last few sessions since trend in US Treasury rates, in particular the two-year Treasury rates, the most sensitive to forecasts – and decisions, too – linked to the Federal Reserve. Yields jumped in last Friday’s session to over 3.9%, at the highest since November 1, 2007, precisely pricing a more hawkish Fed, or at least hawkish enough to be ready to churn out new aggressive monetary tightenings, even in spite of the consequent slowdown of the US economy, in order to reduce the threat – now persistent – represented by inflationary pressures.