The Fed’s rate hikes may be hitting pause soon. In fact, the market seems to believe rate hikes will end this year. That would be great, but inflation is still raging like an out of control forest fire that has yet to be contained. The Fed remains steadfast about extinguishing the inflation flames and in short order.
The problem is the economy is weakening, so more rate hikes are going to slow down the economy even more. As we all know, higher interest rates are the only way to slow demand and hopefully bring down prices. But that may not happen for quite some time, and perhaps not at all.
So let’s discuss the dilemma facing the Fed, and the balancing act they are trying to get right.
Why the Fed’s rate hikes may be almost done
Last week, the Fed Open Market Committee (FOMC) raised interest rates for a fourth time this year, bringing the Fed funds rate to 2.25-2.5 percent. That is their target rate, and very close to the 10 year Treasury bond yield. This is the flattest yield curve in some time, which is a good thing. If the FOMC launches another round of aggressive rate hikes without a similar move in the long bond yield, the curve will invert, and in all likelihood, a recession will be imminent.
Some, including members of the Fed, say a recession could happen but is not probable because the job market is so strong. That reasoning is correct, but it may not matter if supply issues remain a problem and prices continue to rise unnaturally.
The Fed has expressed a desire to reach a neutral rate level or slightly higher. Nobody is on record saying what that number is, but the general consensus seem to believe that 3 percent is neutral, and 3.5 percent is the targeted level. If this is accurate, the FOMC could wrap up rate hikes by the end of the year (they have three meetings left). Fed funds futures are pricing in the next three meetings at a 50bp hike, 25bp hike, and 25bp hike. That would take the funds rate to 3.5% by end of 2022.
We’ll see if that is enough to rebalance the economy, and cool 9 percent inflation rates. As I said above, the market seems to believe the Fed’s rate hikes will slow down or stop following three more bumps higher. I don’t know if it’ll be enough, but a few months of additional inflation data will give us the answer.
