Did the Fed lose the (Dot) Plot?
Federal Reserve Board Chairman Jerome Powell.
The Fed will take it slow rather than repeating the 2013 “Taper Tantrum”.
When it comes to the world of money, put it simply, we are all price takers. The US Federal Reserve (Fed), the custodian of the world’s reserve currency, is the ultimate price-maker. It’s no surprise that markets, investors and even policymakers around the world are clinging to every word from Jerome Powell, the current chairman of the Fed.
Last week was no exception. The Federal Open Market Committee (FOMC), made up of 12 members including Powell and an assortment of regional Fed governors and chairmen, deliberated on the course of the U.S. economy, the trajectory of U.S. interest rates, and, in fact, the financial fate of the world.
It may sound hyperbolic, but as a de facto global risk-free rate, the US policy rate falls within the valuation framework for every financial asset in the world.
The debate over whether US inflation (currently at 3.6%) is “transient” continues. Last week’s meeting was a watershed moment in assessing whether accommodative policies remain in play or whether the time to cut them is fast approaching.
At this point, it is important to introduce the Fed’s Dot Plot. The Dot Plot is an expression of how the 12 FOMC members and six regional Fed bank presidents view policy rates over the next three years and beyond.
Each dot represents an individual’s perspective on where they see the policy rates at the end of each respective year. Since four Fed seats are renewed each year, the Dot Plot is likely to change its mind as well as change its membership. In short, it is not infallible, but is regularly perceived by the market as a signal of intention.
I am presenting the Dot Plot because it is largely responsible for the angst in the markets last week. The most recent Dot Plot indicated that if many FOMC members remain accommodating (lower rates longer), the dispersion of opinions increases.
This resulted in the FOMC’s average estimate for rates now projecting two hikes by the end of 2023, a remarkably hawkish result (higher rates). The market reaction was immediate, with the yield on US 10-year bonds climbing 10 basis points (0.1 percentage point) on release to around 1.6% (1.5% at time of release). writing).
In remarks at the press conference following the FOMC, as well as in subsequent remarks to Congress earlier this week, Powell and other members of the Fed acknowledged the hawkish signal provided by the Dots and aimed to roll back the rhetoric, thus calming the markets.
Move away from short-term gut reactions and the immediate narrative to fully digest what exactly is going on behind the scenes. The Fed is trying to emphasize that it is not behind the inflation curve. He says that while supply chain bottlenecks and labor market dynamics cause pressures in the short term, he still sees inflation as transient. “Jawboning” is still alive and well as a political tool.
Powell also went out of his way to point out the high degree of uncertainty, saying that “no one knows for sure where the economy will be in a few years.” While such a statement may seem trite, this is the crux of the matter. Neither the dot plots nor the rhetoric of recall rests on a separate certainty.
The most pressing structural concern now remains the unintended consequence that stimulus controls have had on the US labor market, perhaps demotivating work and thus tightening the labor supply. With falling commodity prices, lumber and other bottlenecks easing, the tightening labor market will remain a key touchpoint to watch.
The FOMC will meet in July before the summer break is in full swing. After that, the annual Jackson Hole retreat in August will be the main event to watch for other signals. It’s also important to note that the Fed’s current policy tools include not only the fed funds rate, but asset purchases as well.
Currently, the Fed buys $ 80 billion in US Treasuries and $ 40 billion in mortgage-backed securities each month as part of its stimulus package. Keep in mind that policy measures, in particular the phasing out of massive stimulus measures, are a long game. If the Fed is concerned about inflation, the natural reaction function may well be to reduce asset purchases first, before key rates “take off”.
The Fed remembers the “Taper Tantrum” of 2013. Slowly and steadily, the game is winning. Keep in mind that from the initial decline in asset purchases in December 2013, rates didn’t start rising until December 2015. Powell’s term also ends in February of next year, introducing another level of uncertainty.
Right now there are a lot of moving parts. It is important to note that the Dot Plot has been subject to overestimation in the past. Since I started following the Dot Plot over 10 years ago, I have observed how they overtake, to get closer to the realities of the market. The Fed itself has indicated that the Dot Plot is not a decision or a plan. Given this, maybe we shouldn’t panic just yet that the Fed has lost the (Dot) Plot.
Mohammed Nalla, CFA is the founder of Moe-knows.com.