Chief Economist Eugenio J. Alemán discusses current economic conditions.

After the September meeting of the Federal Open Market Committee (FOMC), Federal Reserve (Fed) officials were finally able to convince market participants, after more than a year, that the Fed needed to stay “higher for longer” in terms of interest rates. After the October/November meeting, it seems that Fed officials have an added objective, as Fed Chair Jerome Powell said during the press conference that they needed to see interest rates “persistently high.”

According to Powell, the Fed is still not convinced that monetary policy is sufficiently tight at this time and left the door open to the need for higher rates in the coming months. During the question-and-answer segment of the press conference after the finalization of the October/November FOMC, the Powell indicated that Fed officials were not convinced that the recent increase in the yield on the 10-year Treasury was the result of the institution’s monetary policy stance.

According to the chairman, the fact that yields on the 10-year Treasury have been going up and down as they have during the last several months and have not remained “persistently high” is one of the reasons why Fed officials are still not convinced that policy is sufficiently tight today. And on Thursday, the day after the press conference, markets basically confirmed Powell’s concerns as the yield on the 10-year Treasury declined from 4.9% on the day of the FOMC decision to about 4.66% the day after. On Friday, November 3, 2023, yields on the 10-year Treasury declined further, to about 4.64%. If yields continue to go down because markets believe that the Fed is done with rate hikes or if markets believe the U.S. economy is heading toward a recession or a crisis ensues, as happened with the banking sector crisis back in March of this year, the chances of the Fed increasing rates further will increase once again.

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Before the November 3, 2023, employment report, markets believed, by 80.5% to 19.5%, that the Fed was not going to increase interest rates at its FOMC meeting scheduled for December 12-13. However, after today’s employment report, the odds of keeping rates unchanged increased to 90.2%, reducing the odds of a hike to less than 10%. Typically, the Fed doesn’t like to go against markets. However, if yields on the 10-year Treasury continue to go down as the December FOMC meeting approaches, the expectations for lower long-term rates will increase and that will put pressure on Fed officials to increase rates further in order to convince markets of the need for “persistently high interest rates.”

Only time will tell, but we think that markets should be aware that the Fed’s monetary policy stance depends, fundamentally, on what longer-term interest rates are, and less on where short-term interest rates are. But the Fed has no control over long-term interest rates. Its only instrument for conveying where it wants longer-term rates to be is what it calls ‘forward guidance,’ which is not rocket science or pretty, but it is the only way the Fed has to keep longer-term interest rates higher for longer. Thus, any market expectation that would push longer-term rates lower, as it happened after the October/November meeting or during the banking crisis in March of this year, is going to put more pressure on the Fed and it will increase the risk of the Fed pushing interest rates higher by increasing the federal funds rates.

The market’s initial reaction to October employment numbers confirms the Fed’s conundrum

The initial market reaction from the release of the October nonfarm payrolls numbers is just a confirmation of the difficult environment the Fed has to deal with as it continues to try to convince the markets that it needs to stay “higher for longer.” It also validates our argument that the Fed needs to see long-term interest rates “persistently high” as Powell argued during the press conference after the October/November FOMC decision to keep interest rates unchanged.

The yield on the 10-year Treasury declined further, to about 4.5% after the release of the report that showed less than expected job creation, a higher unemployment rate, and private job creation that was weaker across the board.

The weakness in the employment report probably raised the market’s expectation that the US may be heading into a recession and pushed yields lower as the market speculates that the Fed may be closer to cutting the fed funds rate than previously expected.

This is just the opposite of what the Fed Chair and Fed officials want to see and why Powell was so adamant in making the case that the Fed needs to see “persistently high” long-term interest rates.

Economic and market conditions are subject to change.

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Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.

Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.

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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren’t part of this index.

The Conference Board Leading Economic Index: Intended to forecast future economic activity, it is calculated from the values of ten key variables.

The Conference Board Coincident Economic Index: An index published by the Conference Board that provides a broad-based measurement of current economic conditions.

The Conference Board lagging Economic Index: an index published monthly by the Conference Board, used to confirm and assess the direction of the economy’s movements over recent months.

The U.S. Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners’ currencies. The Index goes up when the U.S. dollar gains “strength” when compared to other currencies.

The FHFA House Price Index (FHFA HPI®) is a comprehensive collection of public, freely available house price indexes that measure changes in single-family home values based on data from all 50 states and over 400 American cities that extend back to the mid-1970s.

Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).

ISM New Orders Index: ISM New Order Index shows the number of new orders from customers of manufacturing firms reported by survey respondents compared to the previous month. ISM Employment Index: The ISM Manufacturing Employment Index is a component of the Manufacturing Purchasing Managers Index and reflects employment changes from industrial companies.

ISM Inventories Index: The ISM manufacturing index is a composite index that gives equal weighting to new orders, production, employment, supplier deliveries, and inventories.

ISM Production Index: The ISM manufacturing index or PMI measures the change in production levels across the U.S. economy from month to month.

ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers’ Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.

Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households. Changes in measured CPI track changes in prices over time.

Producer Price Index: A producer price index (PPI) is a price index that measures the average changes in prices received by domestic producers for their output.

Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.

The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index measures the change in the value of the U.S. residential housing market by tracking the purchase prices of single-family homes.

The S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index seeks to measures the value of residential real estate in 20 major U.S. metropolitan.

Source: FactSet, data as of 7/7/2023