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What will the Fed’s next moves be?

What will the Fed's next moves be?

The commentary by Tiffany Wilding, North American Economist and Allison Boxer, PIMCO Economist, commenting on the latest Fed meeting

The Federal Reserve took another pause in November, and Fed Chair Jerome Powell refused to push market expectations for the additional rate hike in 2023 that many Fed officials had predicted in September. This is despite U.S. economic activity and inflation indicators having accelerated in recent weeks to levels that likely remain too strong to be consistent with the Fed's inflation target. Powell instead indicated that the recent strength may be due to post-normalization. -pandemic immigration and improving labor force participation.

Trying not to raise the relatively low probability of a rate hike in December, Powell strengthened the market's current assessment of the outcome of the December meeting. As a result, we believe that most Fed officials do not expect a hike in December and that the data between now and then is likely to dissuade them from this assumption.

Although US GDP growth was incredibly strong in the third quarter, at 4.9%, according to the Bureau of Economic Analysis, we expect a significant slowdown in the fourth quarter which, based on Powell's press conference, probably won't be enough to urge further tightening. Instead, the Fed seems content to wait and watch how the economy evolves early next year. The pace and extent of the US slowdown will likely determine future rate decisions.

Taking a step back, it appears that the central bank is balancing the strength of the economic data of the last few months with the tightening of financial conditions (including the increase in lending rates for a variety of assets, the strengthening of the US dollar, the asset prices and more). Based on the tone of the November meeting, tighter financial conditions appear to be winning out for Fed officials for now.

Resilient US economy, patient Fed

In our view, Chairman Powell's message suggested that the data would need to surprise on the upside again to prompt the Fed to tighten further. We believe the Fed's patience likely reflects three factors:

– First, Fed officials appear optimistic that supply-side improvements can help offset the effects of persistently strong demand. Indeed, Powell has repeatedly mentioned the significant increase in labor supply and broader supply-side improvements, including reduced bottlenecks (this echoes our September Fed economic forecast – see our post “ Fed seems confident in a soft landing, but we see risks ”).

– Second, as Powell said, officials can be patient as “the tightening stance of monetary policy is putting downward pressure on economic activity and inflation.” Unlike the data-dependency phase we saw in mid-2023, when monetary policy strategy closely followed data developments, officials now seem more patient in the face of resilient data, likely because they believe monetary policy is already restrictive. This explains why Powell was not more forceful in keeping the Fed's options open should US economic resistance persist in the coming weeks.

– Third, the Fed's patience also emerges in the context of a sharp tightening of financial conditions in recent months. Indeed, PIMCO's US Financial Conditions Index (a proprietary index that summarizes information on a variety of financial variables) has reached new highs in recent weeks. The Fed's dovish tone in November could ease financial conditions a bit. Powell noted, however, that “because persistent changes in financial conditions may have implications for the path of monetary policy, we monitor financial developments closely.”

Financial conditions and balance

Markets reacted positively to the Fed's patience, with bond yields falling and the stock market rising. But this only underlines the balancing act that Fed officials will face in the coming months, trying to ensure that financial conditions remain sufficiently restrictive. A notable easing of conditions would add significant pressure on the Fed to tighten monetary policy.

The Fed's balancing act is especially challenging when market movements reflect factors beyond its control, as was the case on the day of the Fed meeting, when long-term bond yields fell after the U.S. Treasury Department announced smaller-than-expected Treasury auction sizes for next quarter (for more details on what is driving bond prices, see our post “ Understanding Rising Bond Yields ”).


This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/quali-saranno-le-prossime-mosse-della-fed/ on Sun, 05 Nov 2023 06:25:32 +0000.