1. Could the U.S. Federal Reserve be Poised to Pivot?
- Based on current data, there’s every reason to believe that the U.S. Federal Reserve will remain resolute in its resolve to combat inflation, even as other central banks start to show signs of wavering.
- But persistent inflation and robust employment data may temper expectations of the Fed slowing down its rate hikes, especially as Powell has made clear that prices continue to remain far too high.
You turn if you want to, the Fed’s not for turning. Or at least that’s what the current data would suggest as other central banks start to ease off the tightening given moribund economies and a slew of other challenges, not least of which have been declining currencies.
Based on current data, there’s every reason to believe that the U.S. Federal Reserve will remain resolute in its resolve to combat inflation, even as other central banks start to show signs of wavering.
But one data point is nearing a key inflection that could encourage U.S. policymakers to think twice about persisting in their hawkish pivot – the Fed’s preferred yield curve that is close to indicating a recession.
U.S. Federal Reserve Chairman Jerome Powell has hinted that he’s willing to risk a recession in order to bring price pressures back in step, but a yield curve that him and his colleagues at the Fed use to measure economic conditions is on the cusp of inverting.
The yield curve on where 3-month rates are now versus where they are expected to be in 18-moonths’ time is on the precipice of an inversion, with the spread between the two falling to just 0.2% this week, from as high as 2.7% in April.
An inverted yield curve is a key warning signal for many investors that a recession is on the cards and many other closely-watched spreads in the Treasury markets have already flipped to zero below zero, an almost certain indicator of a recession.
The prospect of a recession is causing some investors to bet that while the Fed is likely to stick to another 75-basis-point hike in November, it may be forced to move to smaller rates from December onwards, a shift in guidance that could provide a momentary boost for risk assets.
But persistent inflation and robust employment data may temper expectations of the Fed slowing down its rate hikes, especially as Powell has made clear that prices continue to remain far too high.
Because yield curves price in market expectations, they are not necessarily reflective of the conditions on the ground, which are revealed by employment data.
Corporate earnings have been compressed and margins squeezed due to rising material and labor costs, but consumption remains firm and for now, there’s no reason why the Fed would reduce the size of its next most immediate hike, but Powell may pave the way for greater flexibility in the subsequent meetings.
That doesn’t necessarily mean that markets are out of the woods just yet.
Even 50-basis-point hikes will be sufficient to ensure that borrowing costs increase, affecting a slew of industries and consumption.