Fed Pause: It Was Always Just a Matter of Time

In just one day, the Fed has drawn even closer to being finished with rate hikes - or so they hope.  In fact, the market seems to believe the Fed will take a pause soon, perhaps starting the beginning of 2023. Inflation is still raging like an out of control forest fire that has yet to be contained.  The Fed remains steadfast about extinguishing the inflation flames and in short order, or so they say.  

 

The problem is the economy is weakening, rate hikes are going to slow things down even more.  Rate hikes are the only way to slow demand enough to create a situation where prices should come down.  But that may not happen for quite some time, and perhaps not at all.

 

But this past week saw the FOMC raise rates for a fourth time this year, bringing the funds rate to 2.25-2.5 percent.  That is the target rate, and is very close to the 10 yr and other medium term bond yields.  In fact, we have the flattest yield curve in some time, and if the committee launches another big strike of rate hikes without similar move in the long bond, the curve will invert, and in all likelihood a recession will be imminent.

 

Some, including members of the Fed say a recession could happen but would not be 'believable' because the job market is so strong.  The reason is correct, but that may no matter much as supply issues remain a problem, causing prices to rise 'unnaturally'.  

 

The Fed has expressed a desire to reach a 'neutral' level or slightly higher.  Nobody is on record for saying what that number is, but most seem to believe 3% is neutral, and 3.5% is the targeted area the Fed is shooting for.  Hence, the committee could wrap up rate hikes by the end of the year (three meetings left).  Fed funds futures are pricing in the next three meetings as 50bp hike, 25bp hike and 25bp hike. That would take the funds rate to 3.5% by end of 2022.  

 

We'll see if that is enough, but to be sure the market is seeing the Fed as 'slowing it down' from these heavier rate hikes.   Will it help to bring down 9% inflation?  That's a good question, and arguably the answer is no.  A few months more of that high inflation is going to question their strategy.  But that's a subject for another day.