This has been a rather extraordinary year for interest-rate expectations. We came into the year with expectations having been fed by the US central bank. The quotes below come from the 14th of December last year.
So we moved onto expectations of them cutting interest-rate next year and in fact there was even more.
Officials expect rates to fall even lower in 2025, with most officials forecasting they would end up between 3.5 per cent and 3.75 per cent.
So with the official interest-rate in the range 5.25% to 5.5% they signaled future interest-rate cuts approaching 2%.
That lit the blue touch paper for bond markets with the US ten-year yield falling to just below 3.8% whereas now it is 4.21%. That was not supposed to be on the agenda back then. Indeed it is a more favourable comparison that only recently when it was 4.44%.
Governor Waller
Yesterday Governor Waller told us this in Washington DC.
After reducing the policy rate 75 basis points since our September meeting, I believe that monetary policy is still restrictive and putting downward pressure on inflation without creating undesirable weakness in the labor market. I expect rate cuts to continue over the next year until we approach a more neutral setting of the policy rate.
There are elements of deja vu here as we wonder if the Federal Reserve will ramp expectations of interest-rate cuts again as we move into a new year. The crucial bit is “still restrictive” which is reinforced by “more neutral setting” as that suggests even after some more cuts he thinks policy will be restrictive. Indeed he came in even harder with that view later and the emphasis is mine..
The motivation for continuing to cut the policy rate at the FOMC’s next meeting begins with how restrictive the current setting is. After we cut by 75 basis points, I believe the evidence is strong that policy continues to be significantly restrictive and that cutting again will only mean that we aren’t pressing on the brake pedal quite as hard.
That suggests there is scope for a sequence of interest-rate cuts and he even gives a suggestion of where that might lead to.
And there is a ways to go. In September, the median of the projections of FOMC participants was that the federal funds rate would be 3.4 percent at the end of next year, which is about 100 basis points lower than it is today. That number can and probably will change over time, but whatever the destination, there will be a variety of ways to get there, with the speed and timing of cuts determined by economic conditions we encounter on the way.
If he has any sense he will realise that people will see 3.4% as a target come forecast now. That saw the futures contract for a cut in December rise to a 76% expectation and reinforced the falls in bond yields we have recently seen. Then we might see this.
Conversely, based on what we know today, one could argue that there is a case for skipping a rate cut at the next meeting
Inflation
There was a rather extraordinary exposition here.
Overall, I feel like an MMA fighter who keeps getting inflation in a choke hold, waiting for it to tap out yet it keeps slipping out of my grasp at the last minute. But let me assure you that submission is inevitable—inflation isn’t getting out of the octagon.
Whilst I understand the enthusiasm for trying to explain the situation in layman and laywoman’s terms, this is rather extraordinary. He inadvertently highlights it here.
Monthly readings on inflation have moved up noticeably recently, and we don’t know whether this uptick in inflation will persist, or reverse, as we saw a year ago.
As he and his colleagues “don’t know” whether inflation will “persist” how can he say that “submission is inevitable—inflation isn’t getting out of the octagon.” There is more because if inflation is not getting out of the “octagon” why is he doing this?
I will be watching additional data very closely. Tomorrow, we get the Labor Department’s Job Openings and Labor Turnover Survey. On Friday, we get the employment report, which, as I noted, may have misleading payroll data. Then next week, we get consumer and producer price indexes for November, which will allow a good estimate of PCE inflation for the month. Finally, on the first day of the FOMC meeting, we receive retail sales data for November that will give us an idea of how consumer spending is holding up.
That is a very long list for a man who previously assured us he knew what was coming down the road.
Along the way he tells an outright lie and the worst part of it is that he is in a sort of denial. The emphasis is mine.
Inflation based on the Commerce Department’s measure of prices for PCE rose more than expected in September and October and so did “core” PCE inflation, which excludes more volatile food and energy prices and is a better guide to future inflation.
In the major inflation event of this century so far it failed utterly and was a large factor in the “Transitory” debacle. But central bankers continue to prefer theory over reality.
Also there was quite a confession on a subject which we on here are one of the few places that discuss it. Via Forex Live
- Avg inflation targeting framework was very backward looking and “blew up” very quickly
- People are still trying to figure out what the current framework actually means; simpler may be better
Most places have either forgotten it or prefer to forget it
The US Economy
You could easily argue that the numbers below from Governor Waller suggest no further interest-rate cuts are necessary.
Let me turn to the economic outlook. Real gross domestic product (GDP) grew at a strong annual pace of 2.8 percent in the third quarter of 2024, and indications are that growth in the fourth quarter will be a bit slower. An average of private sectors forecasts predicts 2.2 percent, while based on fairly limited data so far, the Atlanta Fed’s GDPNow model currently predicts 3.2 percent.
If the Atlanta Fed is right then you could reasonably ask why cut interest-rates at all? Growth remains strong and inflation is above target. We have also seen something of a turn in the monetary data as the annual rate of growth of the broad measure (M2) is 3.1% and much of that has come in the last 6 months suggesting that the impetus is faster than that. The danger of interest-rate cuts may be shifting back towards overheating fears. Especially if one allows for this.
The Federal Reserve’s balance sheet is now below $7 TRILLION for the first time since August 2020.
In October, the Fed reduced its portfolio of assets by $53 billion, hitting $6.99 trillion.
Since the March 2022 peak, the Fed has shrunk its balance sheet by $1.97 trillion. ( The Kobeissi Letter)
This opens rather a can of worms, but let us stay for now with the monetary implications. We have little experience of the impact of a period of QT but the numbers above suggest that the growth of broad money would have been US $53 billion higher without it. On that road monetary growth may in fact be quite a bit stronger.
Comment
As you can see the Federal Reserve does not have to cut interest-rates this month, but is dropping heavy hints that it will. If we ask the Carly Simon question of Why? I wonder if it is back to one of my longest running themes.
By this time next year, the share of US mortgages with rates in excess of 6% could outnumber those with rates below 3%. A good example of how monetary policy operates with lags. ( Peter Berezin)
In the end it always seems to come round to house prices doesn’t it?