Is Federal Reserve Chairman Jerome Powell a dove or a hawk when it comes to monetary policy? It all depends on the timing. He told us on December 13 that the focus of the Federal Open Market Committee had shifted from how much further to increase interest rates to discussing when, and by how much, to reduce them. That would make him a dove, right?
But the message was different at his subsequent post-FOMC press conference on January 31. He switched to stating that the Fed could not be confident by the March meeting that inflation would come down to the targeted 2% rate. The implication was that there would be no reduction in the Federal Funds rate at the conclusion of the next meeting on March 20.
Several of Powell’s senior colleagues at the Fed also entered the discussion, suggesting that the early, and several, interest rate cuts that the Chairman signaled in December were unlikely to occur. Then came the figures for consumer and producer prices released by the US Bureau of Labor Statistics during the week of February 12. Both figures were above consensus estimates and put paid to complacent forecasts that had expected inflation to move on a steady path downward. In particular, the annual increase in core consumer prices (which exclude food and energy) was 3.9% in January, a rapid pace unchanged from December. By comparison, the Fed hopes to achieve a 2% inflation rate.
FOMC members’ caution was apparent in the minutes of their January 30 - 31 discussions which were released last Wednesday. The collective view indicated that the officials were concerned that a premature easing of monetary conditions could cause inflation to flare up again. They were more worried about the risk of a resurgence of inflation than that of maintaining current rates for too long and pushing the economy into recession.
A forthcoming data point could urge further caution on the part of policy makers. Both headline and core Personal Consumption Expenditure (PCE) price indexes will be released on February 29, and they are likely show an acceleration in January. This is because some components of the elevated Producer Price Index (PPI) inflation in January will feed into the two PCE indexes which the central bank prefers as a signal over other measures of inflation.
An elevated PCE at month’s end could result in the FOMC issuing “dot plots” involving fewer, and delayed, rate cuts at the conclusion of its two-day meeting on March 20. The data could also force the Chairman to issue an even tougher message at his press conference that day. In the past, he has at times watered down the impact of dot plots by providing more dovish messages at his press conferences than the collective FOMC decision would suggest.
Such concerns have already caused the yield on US 10-year Treasurys to gyrate over recent weeks. After falling from 4.2% on December 12 — the day before Powell ruled out rate hikes — to close the year at less than 3.8%, it surged to 4.32% on February 13. The rise was 52 basis points during the first six weeks of 2024. The yield on two-year Treasurys — considered to be a collective measure of market expectations regarding Fed policy — also fluctuated, mirroring movements in longer-dated obligations.
While such sharp changes in US sovereign obligation yields may be a boon for bond traders attempting to divine short-term movements in data and in the Chairman’s views, it is detrimental to long-term capital formation. Borrowers on obligations based on Treasury yields, as well as purchasers of Treasury securities, would benefit from greater stability in the central bank’s monetary policy, attracting more funds to various fixed income securities.
What will happen next with Treasurys? If the PCE index does show an acceleration in inflation in January compared with December, expect Treasury yields to post another jump. Although Treasurys’ reaction may not be as severe as the tantrum last October, the extent of the increase in yield would also depend on statements that the various Fed officials may make — often contradicting each other — and how investors react to it.
Any increase in yield would be a further blow to banks holding fixed income securities that are already under water, to small and medium-sized financial institutions that are trying to prevent deposits from fleeing, and owners of Commercial Real Estate already suffering from vacant office spaces.
That’s when the rate cuts will begin!
While short-term developments are less predictable, investors in ten-year Treasurys with a time horizon of at least six months will probably be happy with their decision to hold. Expect long-dated yields to be significantly lower a year from now.
Dr. Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
srikumar@srikumarglobal.com
@SriKGlobal
February 24, 2024
Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.
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Thank you, Dennis!
Sri, you are a voice of sanity in an insane financial world.