FOMC: Higher for Longer, Confused for Shorter
We look at the FOMC dot plot mix and the journey to this point for positive real fed funds.
The dot plot showed a bias toward one more hike by a margin of 12 members higher and 7 flat through year end.
The 2024 outlook was more mixed with 10 forecasts above a 5.0% midpoint and 9 below with two votes at the floor forecast of 4.375% midpoint and a vote at the ceiling forecast of 6.125%.
The takeaway of “higher for longer” was no surprise, but the confidence in forecasts seemed lower than usual (“humble”) even if the Fed seems to have had a better call on the economy this year than the UST market.
Since last year when we started Macro4Micro, we have been watching the moving parts of the fed funds vs. inflation story, and we were always surprised how little airtime was spent on the topic of negative real fed funds (see links at bottom) until recently (see Fed Funds – Inflation Differentials: Strange History 7-1-23). The CPI numbers for August were mixed (see August CPI: Inflation Fears…They’re Back?! 9-13-23), and the PCE inflation numbers will be out at the end of next week for the next test of inflation for the Fed’s favorite data.
The monetary policy structure at this point at least now is in the zone of positive real fed funds, but it sure took a long time to get there. Those of us who remember the mid-1970s “whiff” by monetary policy on inflation only to be later greeted by a 22% misery index in mid-1980 know caution is not a bad policy.
At least now we get to see much lower absolute interest rates and a much lower UST curve than what we encountered in the late 1980s after the inflation war was already declared a victory (we see the victory year as 1986 at 1% handle CPI. Some say earlier.).
As we cover in the links attached and those below (see Fed Funds vs CPI: Narrowing of the Gap 12-14-22), the extraordinary action by the Fed in 2022, including a streak of four 75 bps moves followed by 50 bps in Dec 2022, was still looking at a negative fed funds rate in what was a seriously challenging battle. The Fed at the time was calling for positive GDP growth in 4Q23. That view was being roundly rejected by the market. The recession flags were waving everywhere (see Unemployment, Recessions, and the Potter Stewart Rule 10-7-22). In retrospect, the Fed was closer to the mark on the economy but very late to the tightening party.
From here the battle will be over Shelter and Energy and how the market will react to the lack of reality in the trailing CPI numbers for Shelter. We should see a positive move in Rent inflation and adverse moves in Energy in the months ahead.
The Services pitched battle outside the bogus (conceptually legless?) CPI Shelter numbers and the Ex-Energy services metrics are still critical variables in the headline number. Raw materials creep is always a worry when oil prices rise since that can flow into goods and the cost of operations for services businesses (freight and logistics charges, heating the place in the winter, etc.). Those operating costs need to be recovered (price) or “eaten” (margin squeeze) by someone.
See also:
Fed Funds vs. PCE Price Index: What is Normal? 10-31-22
Fed Funds-CPI Differentials: Reversion Time? 10-11-22