Summary- The yield curve continues to narrow.
- Chairman Powell argued for a slow and steady approach to policy.
- Three other presidents gave speeches and policy prescriptions.
It's been a few weeks since I wrote a bond market update, which is due to very little happening in the fixed income world. There weren't any speeches or major movements in the bond world. But that changed this week with Fed and ECB Minutes, speeches, and the Jackson Hole symposium. So, let's begin with a look at two key yield curves:
The top chart shows the spread between the 10-year and the 3-month Treasury, which is now below 100 basis points, as is the 10-year Fed funds rate. Remember that most of this movement has come from an increase in the short end of the curve, which means traders don't see meaningful inflationary pressure in the intermediate term. This means we're four rate hikes away from an inverted curve (assuming the 10-year doesn't rally from here).
That means we need to know what the Fed's plans are. To that, we first turn to the Fed Minutes, which were released on Wednesday and contained the following key paragraph [emphasis added]:
Policymakers viewed the recent data as indicating that the outlook for the economy was evolving about as they had expected. Consequently, members expected that further gradual increases in the target range for the federal funds rate would be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective over the medium term. Members continued to judge that the risks to the economic outlook appeared roughly balanced.
Nothing really new on the interest rate policy front from there. But we did get a great speech from Chairman Powell that explained the Fed's general policy preference under his leadership. He first noted that the Fed could make two key mistakes: not acting fast enough to acting too fast. He then explained that economic policymakers use a very imprecise set of variables -- numbers that could radically change or be completely wrong due to a fundamental change in the economic backdrop. As a result [emphasis added]:
I see the current path of gradually raising interest rates as the FOMC's approach to taking seriously both of these risks [of acting too fast or too slow]. While the unemployment rate is below the Committee's estimate of the longer-run natural rate, estimates of this rate are quite uncertain. The same is true of estimates of the neutral interest rate. We therefore refer to many indicators when judging the degree of slack in the economy or the degree of accommodation in the current policy stance. We are also aware that, over time, inflation has become much less responsive to changes in resource utilization.
While inflation has recently moved up near 2 percent, we have seen no clear sign of an acceleration above 2 percent, and there does not seem to be an elevated risk of overheating. This is good news, and we believe that this good news results in part from the ongoing normalization process, which has moved the stance of policy gradually closer to the FOMC's rough assessment of neutral as the expansion has continued. As the most recent FOMC statement indicates, if the strong growth in income and jobs continues, further gradual increases in the target range for the federal funds rate will likely be appropriate.
Barring a cataclysmic financial event, expect Powell to be a disciplined gradualist when it comes to policy. When the Fed raises rates, expect a pause. Don't expect multiple, consecutive actions.
We also had three speeches this week. Let's start with Atlanta Fed President Bostic's prescription on rates [emphasis added]:
Should the recent data unfold in a manner similar to my outlook, I am comfortable continuing to move policy toward a more neutral stance—one where monetary policy is neither accommodative nor restrictive.
The level of the policy rate that qualifies as neutral is not something we know with precision. But we are getting close to the lower part of most plausible estimates of the neutral rate. I don't think we are quite at neutral yet, even after last week's rate hike. But a key policy question going forward is how many more rate increases are required to complete the transition to a policy stance that is neither accommodative nor restrictive.
Bostic is hedging his bets, like a good economist. But he believes rates are still below the neutral rate, which means he's on board for at least one more hike, and maybe two.
Next up is Dallas Fed President Kaplan [emphasis added]:
My own view, informed by the work of my colleagues Evan Koenig at the Dallas Fed [7] as well as John Williams of the New York Fed and Thomas Laubach at the Federal Reserve Board, [8] is that the longer-run neutral real rate of interest is in a broad range around 0.50 to 0.75 percent, or a nominal rate of roughly 2.50 to 2.75 percent.
With the current fed funds rate at 1.75 to 2 percent, it would take approximately three or four more federal funds rate increases of a quarter of a percent to get into the range of this estimated neutral level.
Put Kaplan down as one of the most hawkish members. If he had his way, his policy prescription would come close to inverting the yield curve, all things being equal.
And finally, Kansas City President George spoke. And while she didn't specifically state how many hikes she wants, she offered the following:
I think she's on board for at least one if not two more hikes.
If there's any conclusion to draw from this, it's this: more hikes are coming. I'd guess at least two more. And they won't be sequential. I think the next one will be at the next meeting following by a hike in 4Q18.
Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.