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November
01
2023

Here’s What the Fed Will Do Tomorrow
James Rickards

The Federal Open Market Committee (FOMC) of the Federal Reserve System (the Fed) is meeting today and tomorrow for the purpose of discussing the economy and setting monetary policy going forward.

Today I’m giving you a preview of the meeting, a forecast of Fed policy and what it means for the economy going forward. Let’s start with what’s happening tomorrow with the Fed…

Tomorrow, the Fed will leave its target rate unchanged. That decision will keep the federal funds target at 5.50% as set at the July 26, 2023, meeting.

Over the course of 13 FOMC meetings beginning March 17, 2022, I’ve been correct in all my forecasts including the “skipped” rate hikes at the June and September 2023 meetings. I’m confident I’ll be correct about this meeting also.

This FOMC meeting does not include an updated Statement of Economic Projections (SEP), known as the “dots.” These are the forecasts offered by the 19 Fed governors and regional reserve bank presidents and presented in graphical form as a dot plot.

The dots are meaningless and are regarded as a joke around Fed headquarters in Washington. But Wall Street analysts and mainstream media focus obsessively on the dots like ancient seers sifting through the entrails of a slaughtered goat.

Regardless, the next round of dots will be released at the FOMC meeting on Dec. 13.

This means that the Fed’s decision to sit tight is informed by the same economic data we all see but does not have the benefit of the in-depth projections that the Fed produces in the SEP series.

Will the Fed Hint That the Rate Hike Cycle Is Over?

In addition, I expect the Fed to make reference to the possibility that the rate hike cycle that began in March 2022 is over. In effect, the Fed may have concluded that they’ve reached the terminal rate. That’s the rate at which inflation will come down on its own without further rate hikes.

The lagged effect of prior interest rate hikes will do the job of lowering inflation to the Fed’s target of 2.0%. No further action is required. It’s just a matter of time and patience.

Of course, the Fed will leave itself some wiggle room as they always do. If inflation gets worse instead of better as the Fed now expects, they reserve the right to raise rates in the future. But as of now, they do not expect that to be necessary.

This does not mean the Fed will cut rates anytime soon. The famous “pivot” is still a Wall Street pipe dream. Of course, the Fed will cut rates someday, but as of now a mid-2024 pivot date seems most likely.

There are several serious problems with this policy stance by the Fed.

Not So Fast

The first problem is that the Fed’s fight against inflation is not over. It’s undeniable that the Fed has made progress against inflation since last year. The inflation rate as measured in the Consumer Price Index (CPI) has cooled off considerably since the peak of 9.1% (annualized) in June 2022.

That said, the latest CPI data should give the Fed cause for concern. Here are the CPI readings for the last four months:

The June reading was 3.0%. July’s was 3.2%, August’s was 3.7% and September’s was also 3.7%.

The October data won’t be available until Nov. 14, but it is highly likely to continue this new inflationary trend.

The data for Core Personal Consumption Expenditure inflation (Core PCE), which is the Fed’s preferred measure of inflation, isn’t much better. Here are the Core PCE readings for the past four months:

The June reading was 4.28%, July’s was 4.29%, August’s was 3.84% and September’s was 3.68%.

As was the case with CPI, none of these Core PCE numbers is close to 2%. The rate from June to July actually went up slightly before settling down again. These figures are less encouraging than they may look because they do not include food and fuel.

Core PCE is a weak answer to CPI inflation since food and fuel (including gasoline and home heating) are a large part of the budget of everyday Americans.

The Fed is betting that the signs of recession already in the markets will turn the 3.7% inflation rate around and bring inflation down to 2.0% (the Fed’s official goal) without causing a severe recession.

That’s what the stock market has been betting on also.

What We Don’t Know

There’s no assurance that this analysis is correct. Here’s why: The analysts assume that inflation and recession can’t happen at the same time. If a mild recession is on the way, then inflation will come down on its own. If the inflation continues, it means the recession is not happening and the Fed can go back on the attack against inflation by raising rates without causing a recession.

But the truth is you can have inflation and recession at the same time. It’s not true that recession is the cure for inflation. It’s entirely possible that inflation can have a life of its own even in a recession.

That’s what happened from 1979–1981. We had back-to-back recessions (1980, 1981) but inflation hit 18% and interest rates hit 20% at the same time. There was no correlation between recession and lower inflation. The opposite happened.

The second problem is that the Fed is relying on long-term rates to do the dirty work of killing inflation. The Fed controls short-term rates through its fed funds target rate, also called the policy rate. As investors move out the yield curve to longer maturities, the influence of the Fed is diminished, and the influence of market forces increases.

The 10-year Treasury note currently yields 4.875%. Long-term inflation expectations are around 2.5%. The difference between 4.875% and 2.5% (in this case, 2.4%) is called the “term premium.”

Basically, term premium is a measure of how much “extra” interest over and above inflation that investors demand to hold a particular Treasury security.

A term premium of 2.4% is high by historical standards. The Fed is counting on the high term premium in long-term rates to slow the economy and reduce inflation without the Fed having to raise the policy rate on short-term rates.

In theory, the term premium protects investors against other risks such as actual inflation being higher than expectations, credit downgrades, government shutdowns, wars or other catastrophes. In truth, none of these risks is very high.

If inflation could be higher than expected, it should be built into expectations. Government shutdowns have never resulted in defaults. The U.S. has weathered many wars without damage to the bond market.

It’s All Nonsense

The truth is that the idea of the term premium is nonsense. It’s one of those concepts invented by the Fed to cover up the fact that they don’t know what they’re doing. There’s no empirical evidence to support the existence of a term premium other than concocting a time series from yields and inflation expectations.

If yields are higher than inflation expectations, it’s because the market is experiencing some supply-and-demand imbalance, which could come from liquidity preferences (some institutions hoarding the notes instead of trading them actively), hedging activity or expectations of massive future issuance once the Treasury decides to extend the term of its multitrillion-dollar issues of short-term Treasury bills.

In short, there’s a reason for higher yields in the longer maturities, but it has nothing to do with the Fed’s invented concept of a term premium. That’s important to know. Because whatever might be affecting markets at the moment could just as easily disappear in different circumstances.

That would pull the Fed’s inflation weapon out from under it just when they need it most. That’s one more reason to be concerned that inflation may return even if the economy is in recession.

The bottom line is that the Fed doesn’t really know what it’s doing. We might soon find that out all over again.

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.

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