Send this article to a friend:

August
02
2023

Here’s What the Fed Does Next
James Rickards

The Fed raised interest rates again last week. But that’s the past. What does the future look like?

Today, you’ll receive a full recap of what happened with last week’s Fed meeting. I’ll explain what happened in terms of policy moves, what Fed Chair Jay Powell believes will happen next, and what will actually happen.

Importantly, the difference between Powell’s expectations and market expectations creates opportunities for investors to profit from those competing forecasts.

So, without further ado, let’s break it all down…

Last Week’s Fed Meeting, Explained

Last Tuesday, I offered the following forecast of what would happen at the FOMC meeting the following day:

“On Wednesday, the Fed will raise its target rate for fed funds by 0.25%. That increase will raise the federal funds target to 5.50% after being set at 5.25% at the May 3, 2023 FOMC meeting. After Wednesday, we’ll be back in wait and see mode. … The Fed will not declare that rate hikes are over for the year or that they have reached the terminal rate. They need to keep their options open.”

Here’s what actually happened…

The Fed did raise interest rates 0.25% as I projected. At the same time, they warned that rate hikes are still on the table and they could raise rates again as early as September 20.

That makes twelve Fed meetings in a row going back to March 16, 2022 when I got the Fed forecast right, and my advice that the Fed would leave further rate hikes on the table was correct. Events remain uncertain from here, but it’s so far, so good for my forecasting.

I don’t say that to brag, it’s just that I’ve studied the Fed for years and know what makes it tick. They’re really very predictable once you know how they think and what they look for.

Here’s the text of part of the Fed’s press release issued at 2:00 pm ET on July 26:

“The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 5-1/4 to 5-1/2 percent. The Committee will continue to assess additional information and its implications for monetary policy. In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.”

The FOMC vote in favor of this policy statement was unanimous.

It’s important to look at the Fed’s reasoning behind its moves and to consider what’s next both for the Fed and the U.S. economy.

Fed Chair Jay Powell’s press conference following the announcement is always more informative than the official announcement and this meeting was no exception. Powell’s insistence on flexibility going forward is obvious.

Inflation Over the Target Rate Until 2025?

Powell began with his usual warnings that tight labor market conditions may continue to put upward pressure on inflation. He said, “The labor market remains extremely tight,” and “Labor demand still substantially exceeds the supply of available workers.”

Powell also made it clear “The process of getting inflation back down to 2% has a long way to go.” Then, late in the press conference he dropped this bombshell in response to a reporter’s question about future inflation: “We don’t see ourselves getting inflation all the way back to 2% until 2025.”

That does not mean the Fed will keep raising rates until 2025. 

The Fed has long said that they will reach a “terminal rate” where they will do nothing further and just wait for inflation to come down on its own. But this is the first time Powell has said when he expects inflation to come back to the Fed’s target level even if they stop raising rates.

It pulls the rug out from under those who expect rate cuts in 2024 or believe that the Fed won’t hike rates again this year.

Powell expanded on this theme that rates will remain higher for longer even if rate hikes stop. He said, “It will take time for the full effects of our ongoing monetary policy… to affect inflation.”

He also said, “What our eyes are telling is that policy has not been restrictive enough for long enough to bring inflation down.” And that, “if data tells us … we need to do more, then we will do more.”

One reporter asked whether a strong economy today might give inflation a new boost even in the face of the Fed’s tightening over the past 16 months. She referred to this as the Barbie and Taylor Swift economy — a reference to strong consumer spending on discretionary and even luxury spending in categories such as travel and entertainment.

Powell replied firmly by saying, “Stronger growth over time could lead to inflation,” and “Inflation has proved stronger than we and other forecasters have expected.”

Looking at the short-term instead of the longer-term, Powell made it clear that a rate hike as early as September is very much in play. He said, “We will continue to make our decisions meeting-by-meeting” and a September rate hike is “possible.”

This gave a new definition to the idea of a “skip” policy.

When the Fed skipped a rate hike in June and came back in July with last week’s rate hike, they seemed to be setting up a pattern of raising rates every other meeting until they hit the terminal rate.

Powell demolished that “every other meeting” schedule. He clarified, “we haven’t made a decision to go to every other meeting.” He said that “a more gradual pace could mean two out of three meetings.”

In other words, the skip tempo is not every other meeting; it means a skip in rate hikes every now and then. And that means a September rate hike is back on the table. In Fed jargon, September is a live meeting.

The Long-Term Outlook for Further Hikes

Longer term, the Fed will be “looking at the whole broader picture” and “if we need to keep fighting inflation … we’ll go ahead and raise rates.” This harks back to the June meeting where the “dots” (Fed financial projections) said that the Fed might raise rates twice before the end of the year.

With the July rate hike now accomplished, that still leaves one more rate hike, possibly in September, waiting in the wings.

In conclusion, Powell offered this reminder that, “The worst outcome for everyone would be to not deal with inflation and not get it down now.”

That goes back to “Volcker’s mistake,” which I’ve mentioned before.

Powell does not want to repeat the mistake of Paul Volcker, who also fought inflation with rate hikes, but cut rates too early and came to regret it.

When Paul Volcker was appointed Fed chair in 1979, he immediately set about ending the worst inflation the U.S. has seen since the end of World War II by raising rates.

Then the U.S. was hit with a recession in January 1980, and Volcker was under intense pressure to cut rates in the face of a recession and layoffs.

He blinked. Volcker lowered the fed funds target rate by seven percentage points.

The recession was over by July 1980, but inflation was not. The Fed and Volcker had damaged their credibility as inflation fighters.

This became known as the infamous Volcker Mistake.

If Volcker had ignored the 1980 recession, inflation might have come down by 1981. Instead, it lasted until 1983 and was only defeated by a recession worse than the one Volcker was initially worried about.

Powell does not want to repeat the Volcker Mistake. He knows how that turned out and doesn’t want to end up in the history books for the same thing.

My conclusion: The Fed is not done and more rate hikes are coming. September is the most likely candidate for the next rate hike as of now.

 

James G. Rickards is the editor of Strategic Intelligence. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He was the principal negotiator of the rescue of Long-Term Capital Management L.P. (LTCM) by the U.S Federal Reserve in 1998. His clients include institutional investors and government directorates. His work is regularly featured in the Financial Times, Evening Standard, New York Times, The Telegraph, and Washington Post, and he is frequently a guest on BBC, RTE Irish National Radio, CNN, NPR, CSPAN, CNBC, Bloomberg, Fox, and The Wall Street Journal. He has contributed as an advisor on capital markets to the U.S. intelligence community, and at the Office of the Secretary of Defense in the Pentagon. Rickards is the author of The New Case for Gold (April 2016), and three New York Times best sellers, The Death of Money (2014), Currency Wars (2011), The Road to Ruin (2016) from Penguin Random House.

dailyreckoning.com