The Fed: Peak Hawkishness?

The FOMC’s two-day meeting ends tomorrow. At 2:00 p.m., the committee will issue its statement, and at 2:30 p.m., Fed Chair Jerome Powell will hold his usual after-meeting press conference. For the other Fed officials, the blackout period preventing public comments ends on Friday. The next blackout period starts on March 11.

So we can look forward to lots of commentary from the Fed heads in coming days. Most of it is likely to be hawkish. But on balance, they should be less so than they were during 2022. They are likely today to raise the federal funds rate by 25bps to 4.50%-4.75% and say that it is getting closer to restrictive, implying that they will vote for two more 25bps rate hikes at each of the next two meetings of the FOMC (on March 21-22 and May 2-3).

That would bring the federal funds rate to 5.00%-5.25%, which coincides with the committee’s December 14, 2022 projection of the federal funds rate at 5.10% for this year, falling to 4.1% next year and 3.1% in 2025. Nevertheless, for now, Fed officials are likely to reiterate their intention to keep the federal funds rate at a restrictive level for the foreseeable future and to stress that they have no intention of lowering interest rates anytime soon.

Of course, the Fed heads could turn more hawkish, squawking that this key rate may have to be pushed even higher if the labor market remains too tight and inflation doesn’t continue to moderate toward their goals of 3.1% this year, 2.5% next year, and 2.1% in 2025. (See our FOMC Economic Projections.)

Fed officials remain data dependent, so let’s see what the latest relevant data show:

(1) Employment. December’s JOLTS release and January’s ADP employment report will be out this morning, just in time for these labor market indicators to have some impact on the FOMC’s decision. We know that the labor market remains tight based on the recent historically low readings of initial unemployment claims (Fig. 1).

That was confirmed today by the Conference Board’s January survey used to construct the Consumer Confidence Index (CCI). The percent of respondents saying that “jobs are hard to get” also remained low at just 11.3%, while the “jobs plentiful” response edged up to 48.2%, which is a very high reading for this series (Fig. 2). The CCI’s jobs-hard-to get series is highly correlated with the unemployment rate, which likely remained near recent lows during January (Fig. 3).

Powell and his colleagues have given extra weight to JOLTS’ job openings series. They want to see fewer job openings to reduce the upward pressure on wages. However, the JOLTS series is highly correlated with the CCI’s jobs-plentiful series, so the former probably stayed high during December (Fig. 4). The NFIB small business survey showed a sharp drop in job openings during December, but it also remains historically high (Fig. 5).

(2) Inflation. In a November 30 speech last year titled “Inflation and the Labor Market,” Powell acknowledged that consumer goods inflation is moderating quickly (Fig. 6). He also observed that the rent inflation components of both the CPI and PCED are lagging indicators of rent inflation in recently signed leases, which came down sharply during the second half of 2022.

However, Powell’s major hang-up is the PCED for core services excluding housing. It has been stuck around 4.0%-5.0% since late 2021 (Fig. 7). He blamed that mostly on high wage inflation, which is moderating but remains high. Here are the inflation rates of the six major components of Powell’s PCED for core services excluding housing on a y/y basis and on a three-month annualized basis: transportation (13.2%, 5.9%), personal care (9.8, 10.1), recreation (5.6, 8.7), education (2.5, 2.4), health care (2.4, 1.6), and communications (3.6, -1.0) (Fig. 8, Fig. 9, and Fig. 10).

The three-month inflation rates are mostly below their y/y comparable ones. That certainly doesn’t augur for a higher federal funds rate than 5.25%. But it doesn’t rule out that the Fed will keep the rate at 5.25% for longer until the inflation rate for PCED core services excluding housing is clearly heading down.

(3) Interest rates. Meanwhile, the fixed-income markets are signaling that the FOMC’s monetary policy cycle is nearing the end. The 2-year Treasury yield is a very good leading indicator of the federal funds rate (Fig. 11). It peaked last year at 4.73% on November 3. It was down to 4.21% yesterday. The yield-curve spread between the 10-year and 2-year Treasuries tends to turn negative near the tail end of monetary policy tightening cycles (Fig. 12). It has turned increasingly negative since July 8, 2022.

Try our?research service. See our Predicting the Markets book series on?Dr. Ed's Amazon Author Page. Please see our?hedge clause.