Slow Your Roll
It seems that every Fed meeting this year has felt like the most important Fed meeting. Today was no exception (although we’ll likely say the same in December). The Federal Open Market Committee (FOMC) raised their target rate by another 0.75% to an upper bound of 4.00%. The Fed Funds Rate hasn’t been at these levels since 2008.
Many market participants were looking for an indication that the Fed would slow its pace of hikes in subsequent meetings, and markets found some satisfaction in the statement that “…the committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”
Until Jerome Powell started speaking and reiterated that ongoing increases will likely be needed, and that they want to get to a level that is “sufficiently restrictive to return inflation to 2% over time.”
Realistically, I don’t think much has changed in their stance. If they had said they were nearing the end of the hiking cycle, I would’ve been concerned.
Inflation is not taken care of yet. The Fed’s job is to control prices and maintain employment, not to avoid recessions. We still have a Federal Reserve that is laser focused on solving the inflation problem regardless of the pain their actions may inflict on other parts of the economy.
If inflation stays too high, it would likely throw us into a recession on its own due to the pressure it puts on consumers and businesses. We can scream and shout as loud as we want about how we got to this predicament — and whose fault it is — it doesn’t really matter. We need to get out of it one way or another.
The Fed may slow the pace of hikes, but make no mistake: they’re not stopping.
BeLaboring the Point
One of the notable takeaways from today was that the Fed is acknowledging there is a chance the terminal rate will be higher than their expectations from just a couple months ago. As of this writing, the market was pricing in a terminal rate of 5.0% in May 2023, which is up from 4.75% in September.
One reason the terminal rate expectations continue to rise is because of the stubbornly tight labor market. The ratio of open positions to unemployed workers went back up in September to 1.86.
It’s natural to think a strong labor market is good. And it is good…for workers. It’s not good for companies facing higher wage costs and a shortage of employees. Since wage growth is stickier than other inflation components, it’s likely to be with us for a while, and likely to pressure corporate margins as a result. When margins get pressured enough and companies have cut costs everywhere they can…they start laying off workers.
A labor market this tight has a buffer to soften further before it becomes concerning, so for now it’s just more confirmation that hikes can continue and that the level of rates can remain elevated for some time.
In my opinion, the rally we’ve experienced since early October is under threat as the market comes to grips (again) with the fact that this is a decidedly hawkish Fed. And a Fed that would rather go too far than not far enough.
Tight is Right
That all said, we’ve done some serious work on the tightening front. And we know there’s a lag between policy moves and economic effects. Financial conditions have tightened considerably since the start of this year, and this is probably one chart the Fed likes the looks of right now.
As tightening works its way through the real economy, there’s good reason to expect further softening in demand, housing, labor, manufacturing, and in turn, inflation. We can also comfortably expect that those forces are currently at play — we just haven’t seen them in the data yet.
Call me “Lower Liz,” but it’s possible that this meeting was a catalyst for giving back some (or all) of the October rally. That wouldn’t be the end of the world because it would mark the end of another bear market bounce. The more of them we put in the rearview, the closer we are to the real bounce. In order to know when that real bounce is taking shape, I think we still need to see meaningful softening in labor, and I’d expect that to show its face before the end of the year.
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