On Thursday, November 2nd (Beijing time) at 2am, the Federal Open Market Committee (FOMC) of the Federal Reserve will announce its second to last interest rate resolution for this year. Currently, the market generally expects the FOMC to continue to suspend interest rate hikes once, while retaining the possibility of raising interest rates again at a meeting in mid next month to combat stubborn inflation. However, due to the recent acceleration of long-term US bond yields, which has pushed up borrowing costs, the Federal Reserve may also consider whether this effect can be considered as a "rate hike". In addition, how to deal with the complex phenomenon of significantly slowing inflation but increasing consumer spending and recruitment is also a challenge for FOMC.
Jonathan Millar, a senior economist at Barclays in the United States, pointed out in a comment email sent to reporters at the Daily Economic News that recent speeches by Federal Reserve officials, including Powell, have sent a strong signal that the FOMC tends to remain cautious at upcoming meetings, and suspending interest rate hikes tomorrow seems to be a certainty. However, Millar still maintained his expectation for the December interest rate meeting that strong economic data will ultimately force the FOMC to raise interest rates by an additional 25 basis points at the December meeting.
Under the soaring US bond yields, FOMC faces more challenges
Due to the increasing expectations in the market that the Federal Reserve will maintain high interest rates for a longer period of time, as well as concerns among some investors about the increase in US bond issuance, US bond yields have accelerated in the past month. Among them, the 10-year US Treasury yield, known as the "anchor of global asset pricing," broke the important psychological threshold of 5% twice on October 19 and October 23 Eastern Time, setting a new high since the global financial crisis in 2007.
Powell stated in his speech on October 19th that if the reason for the rise in US Treasury yields does not reflect market expectations for a more aggressive Fed rate hike path, then the rise in long-term US Treasury yields over the past three months may replace a Fed rate hike.
Higher borrowing costs mean higher costs for consumers to purchase houses, cars, or expand their business through loans. This will cool the overall economy by putting a brake on demand and recruitment, thereby helping to curb price increases. The recent accelerated upward trend in long-term US bond yields has led to fixed interest rates on US 30-year mortgages approaching 8%, reaching a new high since 2000. In addition, interest rates on car loans, credit card loans, and other loans in the United States are all rising.
The soaring yield of US treasury bond bonds has led to the tightening of the financial environment, which many Fed officials said may reduce the necessity of raising interest rates at this meeting. For example, Deutsche Bank estimates that the recent surge in US bond yields may be equivalent to three 25 basis point rate hikes by the Federal Reserve.
In addition, Powell will also face more questions about how Federal Reserve economists and policymakers can assess the potential impact of rising borrowing costs on the economy. Former Boston Fed President Eric Rosengren recently pointed out that "although the Federal Reserve is not responsible for the recent rise in US bond yields, I believe this is an issue that monetary policy must consider." He believes that tightening financial conditions is what Federal Reserve officials hope to see, but the rise in US bond yields is not caused by the Federal Reserve's policies.
According to the "Federal Reserve Observation" by Chishang Exchange, as of press release, the futures market believes that the probability of the Federal Reserve keeping interest rates unchanged tomorrow morning is as high as 97.7%, while the remaining 2.3% probability is a 25 basis point rate cut. That is to say, the futures market has no expectation of the Federal Reserve raising interest rates at this meeting.
In addition, futures traders currently also expect the FOMC to "hold still" next month and use the current 5.25% to 5.50% as the terminal interest rate for this tightening cycle, maintaining it until mid year next year, and then entering the rate reduction cycle at the meeting at the end of July next year.
However, it should be pointed out that the above expectations come before tomorrow's FOMC policy statement and Powell's speech, and once the statement and speech point to hawks, or Powell suggests that interest rates will continue to rise, market expectations will immediately change. In addition, the non farm employment data for October will not be released until this Friday (November 3rd) Eastern Time, so the Federal Reserve's interest rate decision tomorrow morning did not take into account the key employment data for October. FOMC will digest non farm and inflation data for October and November before the mid December meeting.
Core inflation has significantly slowed down, but consumer spending and recruitment have increased
In addition to the accelerating rise in US bond yields or borrowing costs in recent times, inflation and employment dynamics are also important factors to consider in the Federal Reserve's interest rate decisions.
The Wall Street Journal reported that the main issues of market concern may be answered by Powell at a press conference after the policy statement was released. Powell may say he hopes inflation will continue to slow down, and there are signs that US economic activity and recruitment are cooling down after strong growth from July to September. Another issue is how FOMC officials can determine whether they are moving in the right direction.
The Daily Economic News reporter noticed that since June, core inflation in the United States has significantly slowed down, but consumer spending and recruitment have been increasing, which has also posed challenges for Federal Reserve officials, as economic activity typically weakens as inflation slows down. This strange phenomenon also makes it difficult for FOMC to determine how the economy and inflation will develop in the future. A continuously growing economy may actually exacerbate people's concerns that if the Federal Reserve does not continue to tighten policies, inflation will not continue to slow down.
In addition, the initial estimated data released by the US Department of Commerce on October 26th showed that the actual gross domestic product (GDP) of the United States increased by 4.9% year-on-year in the third quarter of this year, exceeding market expectations; The non farm employment population in the United States increased by 336000 people in September, the largest increase since the beginning of this year, far exceeding the expected 170000 people.
However, Bank of America's credit strategist stated in a research report to clients this week that "despite accelerated GDP and employment growth, the Federal Reserve may still maintain interest rates unchanged. Due to the rise in long-term Treasury yields, Federal Reserve officials have adopted a more cautious tone, believing that the interest rate market has actually completed some tightening. At a press conference, Powell may reiterate that the Federal Reserve is' acting cautiously '
Jonathan Millar, a senior economist at Barclays in the United States, also pointed out in a comment email sent to reporters at the Daily Economic News that, Federal Reserve officials have recently issued strong signals indicating that the FOMC tends to remain cautious at the upcoming meeting, and a pause in interest rate hikes tomorrow seems certain. However, as we discussed earlier, almost all major economic data since the September meeting has been significantly stronger than expected. Therefore, we expect tomorrow's policy statement to shift the assessment of the speed of economic activity expansion from 'robust' to 'robust' ’Upgraded to 'strong' and reiterated the previously mentioned wording of a recent slowdown in employment growth
To balance this, we expect a new wording to be added in the second paragraph of tomorrow's policy statement, which acknowledges the potential negative impact of rising long-term US bond yields and the risks posed by increased geopolitical tensions to global economic activity. As for forward-looking guidance, we expect the policy statement to maintain the tightening trend previously stated, "Millar wrote.
When discussing the expectations for the FOMC meeting in mid December, Millar pointed out that, Our model shows that the recent rise in long-term US Treasury yields has indeed had some degree of inhibition on economic growth, especially considering the offsetting effect of other financial indicators. Given that our expectations for fourth quarter GDP are much higher than market consensus (2.0%), we still maintain our previous expectation that strong economic data will ultimately force the FOMC to raise interest rates by another 25 basis points at its December meeting