Markets are still in denial about the increasingly hawkish Fed.
No, the Fed is not going to hike rates by half a percentage point at each meeting, and it’s not going to hike rates via secret teleconferences in between meetings to spring a monetary shock on the market, and it’s not going to hike rates by one full percentage point per meeting, as it had done in November 1978, in October 1979, in February 1980, and four times in a row between September 1980 and May 1981. And it’s not going to drive the federal funds rate above 19%. Nope. Those days are gone. “Hawkish” in those days meant something different. Those were the Volcker days of cracking down on double-digit inflation.
When we talk about a “hawkish” Fed today, we mean the “gradual” removal of accommodation, as it’s called, in baby steps, doing in an entire year what Volcker accomplished in a single meeting, namely raising its target range for the federal funds rate four times, 25 basis points each, for a whopping total of one percentage point in 2018. That’s “hawkish” today, after years of ZIRP and QE.
Many on Wall Street had still been stuck on two rate hikes this year, even though the Fed had signaled in December that there would be three hikes this year.
But today, Jerome Powell, during his first semi-annual testimony as Fed Chairman before the US House of Representatives’ Financial Services Committee, joined the chorus of those Fed governors who’re open to four of these tiny rate hikes in 2018. He wasn’t the first to do so publicly, but he’s the most powerful among the FOMC members.
His prepared remarks were about how strong the economy is, that the Fed would stick to its path of “gradual” removal of accommodation, and that it would “continue to strike a balance between avoiding an overheating economy and bringing … price inflation to 2% on a sustained basis.”
After his prepared remarks, he was asked what would cause the Fed to hike more than the three times the Fed had penciled in for 2018 at the meeting in December. And off script, he opened the door to a fourth rate hike. This is what he said:
“You’re right that every quarter, every participant in the FOMC submits a projection of what they feel is going to happen to the economy and also their projection for appropriate monetary policy. And at the December meeting, the median participant called for three rate increases in 2018.
“Now since then – we will submit another projection, all of us, in three weeks – but since then, what we’ve seen is incoming data that suggests that strengthening in the economy. We’ve seen continuing strength in the labor market. We’ve seen some data that will, in my case, add some confidence to my view that inflation is moving up to target.
“We’ve also seen continued strength around the globe, and we’ve seen fiscal policy become more stimulative.
“So I think each of us is going to be taking the developments since the December meeting into account and writing down our new rate paths as we go into the March meeting, and I wouldn’t want to prejudge that.
This is how the Fed wants to prepare the markets. The old days of administering a “monetary shock” to get a point across are long over. Now it’s all about “forward guidance.”
And when it became clear today that Powell joined the chorus of Fed governors that are open to four of these tiny rate hikes in 2018 and that the QE Unwind will proceed as planned – “I like our current plan,” he said when pushed about the need to speed up the QE unwind – the markets had a small hissy-fit.
The Dow dropped nearly 300 points. The S&P 500 dropped 1.3%. Treasury bonds fell, with yields rising across the yield curve. The two-year yield hit 2.27%, the highest since September 2008. The 10-year yield bounced back to 2.9% at the close. The dollar rose, with the WSJ Dollar Index reaching the highest level since February 9.
But financial conditions, though they have tightened somewhat recently, remain very easy. The costs of borrowing money, even for junk-rated companies, remain very low. Risk premiums are minimal. Excess liquidity is still trying to find a place to go. Investors are still chasing yield. And it will take the Fed a long time at the pace it is going – barring the application of a surprise “monetary shock” – to persuade the markets that it is serious about the end of super-easy money.
Surging home prices have primed the housing market for this. Read… What will Spiking Mortgage Rates, High Home Prices, & the New Tax Law Do to the Housing Market?
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