Despite volatility, the stock market appears to heading for a slight gain of around 0.5 percent for the week. Bond yields trended higher, with the benchmark 10-year trading at 1.66 percent versus last Friday’s level of 1.57 percent. The core Consumer Price Index topped expectations in August, rising 0.2 percent versus expectations of 0.1 percent. Retail sales unexpectedly declined 0.3 percent and industrial production fell 0.4 percent.
Reading the Fed’s Tea Leaves
Last Friday, the markets woke up from a relatively boring summer to volatility.
Boston Federal Reserve President Eric Rosengren gave a hawkish perspective by noting that waiting too long to raise interest rates may lead to an overheating economy. Both stock and bond market investors read into that statement that a September rate hike may be back on the table and subsequently sold off. Monday, Federal Reserve Board Governor Lael Brainard laid out her recommendation for patience in removing the accommodating federal policy, which seemed to calm market fears. What message can we take away from these two very different speeches?
First, let’s look at where we are today. The Federal Open Market Committee (FOMC) currently has the federal funds rate pegged in a range of 0.25 to 0.50 percent, which is certainly low, but not as low as the negative interest rate policy we have seen in some parts of the world. The federal funds rate has been below 0.50 percent since December of 2008. This is an extremely long timeframe for very accommodating interest rate policy, by historical standards. While the U.S. economy has been on a course of moderate improvement, the global economic downturn has impacted the FOMC’s willingness to raise rates.
Why do we see conflicting messages from Fed members? The FOMC comprises 12 members: seven members of the Board of Governors of the Federal Reserve System, the president of the Federal Reserve Bank of New York and four of the remaining 11 Federal Reserve Bank presidents. Complete consensus between 12 individuals is unlikely and speeches tend to showcase each viewpoint.
Additionally, the Federal Reserve seems to float “trial balloons,” in the form of regional Fed speeches, to assess the type of market response that could occur if the Fed were to change rates. The last few such hawkish remarks have resulted in both bond and stock market selloffs. These remarks may be warning investors that the FOMC is considering raising rates. Fed Governor Brainard’s dovish comments balance out the hawkish remarks and seem to suggest that the pace of any future rate hikes would be slow and steady. The FOMC also continues to stress “data dependence,” suggesting that any change in economic conditions will be taken into consideration.
With the Fed sending mixed messages, what will next week bring? Markets will anxiously await the FOMC’s committee policy announcement on September 21. Fed futures imply that the chance of a rate hike occurring next week is low, around 20 percent. Despite Rosengren’s comments, we expect that the FOMC will hold at the 0.25 to 0.50 percent target rate. Near-term expectations for inflation should remain low and unchanged.
Also, we expect no change in the Fed’s expectation for labor markets and little change to their 2-percent expectation for gross domestic product growth. A more moderate stance may set the stage for a potential rate hike by year-end. Fed futures imply that the chances of a hike in November rise slightly, to 28 percent, with the chances of a hike in December rising to 53 percent.
Our Takeaways for the Week:
- FOMC will announce policy statement on September 21
- We expect the statement message to be largely unchanged, despite Fed chatter this week