We are in the quiet period here in the United States where the Federal Reserve conducts its media blackout prior to its next Federal Open Market Committee meeting. The markets are expecting at least one more change in the federal funds rate, the rate at which member banks lend each a portion of the reserves that they keep in the vault of their federal reserve district bank.
The next meeting takes place on October 31st and November 1st.
For most consumers, a rate change has no direct impact on them. They may feel a rate change indirectly, however, as lenders tend to increase their lending rates in accordance with an increase in what is called the federal funds target range. So, if the FOMC announces an increase in the target range, banks may increase their lending rates for mortgages, car loans, and credit cards.
For traders, a rate increase may be indicia of an increase in demand for the US dollar. Higher rates attract investors to U.S. securities and they will have to buy dollars in order to buy securities such as U.S. Treasurys, corporate debt, or equities.
The mainstream financial media and market analysts have been touting the narrative that the Federal Reserve will keep its rates higher for longer. Is this to be interpreted as keeping rates at this level for another year or two? Or should this be interpreted as consistent increases through, say, 2025?
As mentioned earlier, higher rates attract investors, and we may see further strengthening in the dollar for this reason. But as interest rates climb, people holding assets may see decreases in asset values as there is an inverse relationship between a bond or a house and interest rates. Higher yields may be good income wise for bond holders, but for people or businesses bringing collateral to the table in exchange for credit, they may have to increase the amount of collateral or the value of the collateral to get loans.
For wage earners who do not hold much in terms of assets, decreases in the value of assets held by their employers will constrain their employers’ ability to borrow which in turn impacts the employers’ ability to do business including paying their employees.
It’s all relative and related.
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Below, I summarized some remarks made by four Federal Reserve bank presidents made over the last four weeks. These Federal Reserve bank presidents sit on the FOMC and their comments and thinking will have weight on what the FOMC does policy wise.
Lori Logan, President & CEO, Federal Reserve Bank of Dallas (9 October 2023): Fed should stay focused on returning to its two-percent target. High inflation remains the most important risk. Restrictive financial conditions are necessary to restore price stability. Longer term rates impact economic activity more than the federal funds rate. The relationship between the federal funds rate and longer-term rates is not fixed. Longer term rates increase for three reasons.
- Market participants anticipate economic data calling for a higher federal funds rate.
- Market participants judge overnight rates will be higher over the long term as a result of lasting changes in the economy.
- Interest rate premiums i.e. risk, have increased.
For example, a term premium can be determined by subtracting market participant expectations for the average fed fund rate over ten years from a zero-coupon Treasury yield.
Source: Financial conditions and the monetary policy outlook – Dallasfed.org
Patrick Harker, President & CEO, Federal Reserve Bank of Philadelphia (20 October 2023): Holding the policy rate steady is a prudent position to take. Consumer resilience is a head scratcher. Consumers have retained their spending power. The Fed will not tolerate a reacceleration in prices. Seeing signs of reinflation is no reason to overreact to variability in data. The Fed has to separate noise from real signals while being data dependent.
Holding rate steady is restrictive policy that keeps inflation down. Doing nothing is doing something. I do not project a recession even in the face of possible GDP contraction.
Fed needs to closely watch the data before making a policy decision on moving rates in either direction.
Source: Outlook for Economic and Banking Conditions (philadelphiafed.org)
Neal Kashkari, President and CEO, Federal Reserve Bank of Minneapolis (10 October 2023).
While the overnight interest rate has no direct impact on the consumer, it influences longer term rates which impacts mortgages, car loans, etc.
There may be optimism fueling rising rates. People may also be thinking that the Fed will be aggressive over the next ten years. The federal government issuing more debt may be impacting higher yields as well.
It is possible that higher bond yields will give the Fed less to do on inflation. If higher yields are based on expectations, the Fed may have to follow up on how to meet these expectations.
Neel Kashkari at Minot State University | Federal Reserve Bank of Minneapolis (minneapolisfed.org)
Austan Goolsbee, President and CEO, Federal Reserve Bank of Chicago (28 September 2023).
America does not need a recession to tame inflation. Tighter policy (increased interest rates, contraction of money supply) could create the problem you are trying to avoid: recession.
Mr Goolsbee does not comport with the traditionalist view on inflation (increasing unemployment, slowing down growth.) Soft landings are rare.
Non-monetary shocks are influencing the economy and the monetary policy environment is different today. Tying monetary policy too closely to contemporary output and labor market readings risks the wrong policy outcomes.
Alton Drew
22 October 2023
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