Over the last six weeks, U.S. Mortgage rates have fallen and stock prices have risen, while yields on corporate bonds have declined. These are all indicators that financial conditions are improving, even though the Federal Reserve is still fighting against 40-year-high inflation.
However, unlike last summer’s Fed Chair Jerome Powell who resisted market movements with great force, the U.S. central banks may be able to accept it this time around.
Next week, the Fed is likely to reduce what has been an alarming rate of interest rate rises this year. Powell expects a half-point increase in policy rate to range from 4.25%-4.5%.
In an effort to reduce borrowing costs sufficiently to support economic growth, the Fed increased rates by 75 basis point at its four most recent meetings.
The Fed’s December rate hike was smaller than expected, meaning that it is near to stopping rate increases altogether. Data showing that inflation might be cooling, and comments from Powell saying that he and others “does not want to tighten,” have all contributed to the recent ease in financial conditions.
Powell and other policymakers have repeatedly said they will not stop raising rates. They won’t raise them until they feel that inflation is heading down to the Fed’s goal of 2%.
Sonia Meskin, an economist at BNY Mellon Investment Management, said that they aren’t as worried about “loosening financial conditions” now as in summer when rates were rising.
She said, “I expected him to repeat that they will keep policy restrictive for some period, but I don’t believe he is likely that he will say more beyond that. The reason is that they want to keep all their options open.”
Powell stated late last month that the Fed would likely have to increase the policy rate “somewhat more” than the 4.6% projections of September policymakers.
Expect fresh projections from Fed policymakers to be released following next week’s meeting. They will also include a forecast that no reductions to the policy interest rate are possible until 2024.
However, inflation data and readings from the labor market may be lower than anticipated. This allows the Fed to ease financial conditions while halting rate increases at a lower level than usual.
But things may get worse because of labor supply limitations that continue to feed higher wages, pushing up inflation. Powell mentioned this possibility in his recent comments and might reaffirm it next week.
Uncertainty remains about how strict policy is. The effect of Fed forward guidance and cuts to balance sheets on monetary policy was recently captured by researchers at San Francisco Fed. They concluded that the Fed funds rates suggest that monetary policies are actually more tight than they really are.
This could be a reason to argue that both the labor market and economy are likely to shrink next year. It would also help ease inflation pressures.
Economists expect Powell will continue to stress the dangers of not being enough aggressive in fighting inflation, rather than going too far. A rise in unemployment is a necessary but painful part of this process.
Ryan Sweet from Oxford Economics stated that the Fed would like financial markets to be more tightened. This is because it slows down the economy and lowers inflation. However, this will most likely lead to an increase in unemployment. They are becoming frustrated.”
Average 30-year fixed-rate residential mortgage loan rates for residential properties rose more than 7% to 7% last October, from 3% the previous year, and fell to 6.3% during the week. The yields on corporate riskiest debt are now at 8.6%, down from 9.6% mid-October. And those drops came despite the Fed lifting its policy rate by three-quarters-of-a-percentage point, to 3.75%-4% in early November.
The unemployment rate has held steady at 3.7%. This is lower than the Fed’s expectations, which was a result of tighter policies slowing down the economy.
The Fed is more likely to ease financial conditions in summer than now because it has raised its interest rates nearly four percentage points.
The government expects that the economic effects of higher borrowing costs will take some time to start to show.
Eric Stein, Morgan Stanley Investment Management said that while they wish to avoid a pre-emptive easing of financial circumstances, it was more expensive than now. They are closer to getting there.