By Yasin Ebrahim
Investing.com – Federal Reserve Chairman Jerome Powell will be the focus next week when he attends the Economic Club of New York on Thursday, where the focus will be on whether the Fed chief’s recent comments from fellow Fed members support that a continued rise in Treasury yields could reduce the need for a final rate hike this year.
“In light of recent comments from other Fed officials, market participants will be closely watching to see whether Fed leadership shares the same view that higher market rates, if sustained, will reduce the need for a final rate hike this year,” MUFG said . a note.
Since the Fed’s September meeting, the overarching narrative of “higher for longer” interest rates has swept the markets and the bond market has been on course correction. A sharp sell-off in government bonds has pushed yields, especially on longer-term bonds, to a 20-year high.
The rise in interest rates, which San Francisco Fed Chair Mary Daly recently suggested is equivalent to about one rate increase, could indicate that the risk of raising rates too high and pushing the economy into recession is increasing. gets bigger.
How much will the threat of ‘two-sided’ risks affect Powell?
At the most recent FOMC news conference in September, Powell identified the risk of too much tightening – or an increase in interest rates too far above “sufficiently restrictive” levels – as an emerging problem.
In the face of this growing two-sided risk, the “common sense thing to do,” Powell said, is to “act a little slower” on rate hikes as you approach a sufficiently restrictive policy. With many at the Fed still arguing that the impact of the 11 interest rate hikes observed so far has not yet fully rippled through the economy, the need to move more slowly in tightening appears to be increasing.
A cautious approach to monetary policy has been echoed by several participants in the Federal Open Market Committee in recent weeks.
“There appears to have been a coordinated effort by Fed officials to raise more concerns about the sharp rise in US yields, which has contributed to a significant tightening of US financial conditions, equivalent to one or two 25 basis point rate hikes by the Fed.” Added MUFG.
This apparent shift in tone among Fed members toward a less hawkish bias became more apparent following the release of the minutes of the September FOMC meeting, when a “majority of participants judged that another increase in the target federal funds rate at a future meeting would probably be appropriate. .”
Markets appear to be betting that the Fed is ready, with interest rate futures pricing implying a less than 30% chance of another rate hike this year.
The potential dangers of endorsing a less aggressive attitude
But endorsing the views of his Fed colleagues is not without risk for Powell. It could reinforce expectations that the Fed’s cycle of rate hikes is over, clouding the Fed’s higher narrative for an extended period, potentially reversing some of the recent tightening in financial conditions .
“If those higher long-term rates are higher because their expectations about what we’re going to do have changed, then we may actually have to meet their expectations to keep those rates up,” Minneapolis Fed Chairman Neel Kashkari said earlier. this week.
Kashkari’s comments remind us of the Fed’s past reservations about “unwarranted” easing of financial conditions, especially if motivated by a misunderstanding of its response function.
Powell may give a nod to rising interest rates, but not much more
However, Powell could also choose to pour cold water on the significance of the rise in government bond yields, Scotiabank says, attributing it to a litany of “temporary forces,” including larger-than-expected issuance, or supply , of government bonds with “larger and more frequent auction sizes.”
The U.S. Treasury Department has issued a wave of U.S. Treasury bonds amid plans to borrow a near-record $1.859 trillion in debt in the second half of 2023 to replenish depleted treasuries after depleting reserves to finance government operations – as a result of the debt crisis. ceiling debacle earlier this year.
While the potential risk of a government shutdown in mid-November could lead to a new need for the Treasury Department to raise more money, Powell could argue that the pace at which the Treasury replenishes its appropriations will eventually slow, which will reduce supply pressure on US government bonds. have driven up returns.
Leverage data dependency and maintain flexibility
Recent history suggests that Powell is unlikely to imply that the Fed is done raising rates. By sticking to the forecast of a final rate hike this year, the Fed has not only been able to maintain its policy flexibility, but also helped manage market expectations, which until recently have been the Fed’s “higher for longer” narrative at any time fought. play.
Powell could draw on the recent mix of economic data to emphasize the need for the Fed to maintain the status quo data-driven policy.
Recent data shows that the core CPI is rising again. The September wage figures report was a positive surprise. And economic growth, which Powell said in September was a factor behind FOMC members cutting their rate cut forecasts from four to two next year, remains resilient.
“This is the fifth consecutive quarter in which GDP growth has blown away consensus expectations, with an average third-quarter tracking of 3% q/q SAAR,” Scotiabank Economics said in a note.
With the Nov. 1 Fed meeting just weeks away and rate hikes largely baked into markets, Powell will likely opt for balance in his comments by acknowledging the recent rise in yields, but he suggests that more time is needed to assess whether this It is likely that this will persist as the Fed’s data dependence policies are reiterated.
This could appease the monetary policy hawks, whose numbers continue to dwindle, and the doves, allowing the Fed to maintain the status quo, rather than shifting communications at a time when many agree that the last mile toward an inflation rate of 2% will be a challenge. .
Ultimately, the extent to which Powell endorses a less hawkish stance, or not, may well depend on the extent to which the recent tightening of financial conditions has increased the risk of a hard landing or something breaking down in the economy.
Powell will deliver his speech on October 19 at noon ET.
