Freshly-awake bond vigilantes are getting ready to ride into Jackson Hole next week to have some fun and scare the central bank folk.
Imagine their surprise if Federal Reserve Chairman Jerome Powell rides out to join them.
That could be how the Fed’s conference in Wyoming plays out this year, economists said.
What will Powell say, in his speech scheduled for shortly after 10 a.m. Eastern on Friday, August 25th?
The conventional wisdom is that Powell will not welcome the recent run-up in Treasury yields.
Ed Yardeni, who coined the term “bond vigilantes”, is in this camp.
“The Fed can’t really afford to see this bond yield keep going up. So they have got to calm the bond market down,” Yardeni said, in an interview on Bloomberg.
Krishna Guha, vice chairman of Evercore ISI, agrees. “Our hunch is the Fed will try to avoid adding fuel to the fire in the hawkish direction,” he said in a note to clients.
But Matthew Luzzetti, chief U.S. economist at Deutsche Bank Securities thinks the Fed will welcome higher yields because recent data suggests U.S. economic growth is too strong. The Atlanta Fed’s GDPNow tracker projects growth at a 5.8% annual rate in the current quarter.
See: Hate to spoil the party, but there’s a new risk in town — a ‘no landing’ economy
Higher yields will serve to tighten financial conditions and lending. These conditions, in turn, might put the needed brake on the economy needed to get inflation down.
“I think that the Fed should be comfortable with higher rates, tighter financial conditions, because you know, some of the things that they need to see are slower growth and a labor market that’s coming into better balance. Tighter financial conditions will help with that,” Luzzetti said, in an interview.
“I’m not of the view that they are thinking this is an inappropriate tightening of interest rates,” he said.
Financial conditions had eased a lot earlier in the year, he noted.
The recent pickup in yields has actually brought the market into better alignment with the Fed’s thinking about rates over this year and next, Luzzetti pointed out.
Economists at Deutsche Bank still expect the economy to fall into recession some time next year.
In July, the Fed raised its policy interest rate by 25 basis points to a range of 5.25%-5.5%. That move was the 11th hike of this cycle and brought rates to the highest level in 22 years.
The Fed has penciled in one more 25 basis point rate hike before the end of this year. Officials forecast 100 basis points of cuts in 2024.
Minutes of the Fed’s July meeting revealed that “most” Fed officials continue to see upside risks to inflation “which could require further tightening of monetary policy.
These officials said that some softening in labor market conditions was needed to reduce upward inflation pressures.
There were also some more dovish Fed officials who worried about the central bank over-tightening monetary policy.
Fed officials said the data in the next few months should clear things up.
Nathan Sheets, global chief economist at Citi, said Powell will stick to his recent statements that the Fed is data dependent.
Luzzetti said the Fed is moving meeting by meeting. Powell will likely repeat that there are too many important data points between now and September to gauge the central bank’s decision at that meeting.
Powell and his colleagues believe interest rates are now “restrictive” or at a level to bring inflation down.
Officials are less certain if the level of rates are “sufficiently restrictive” to bring inflation back to the Fed’s 2% target, said Nathan Sheets, chief global economist at CIti.
“That’s a more subtle judgement. Hawks at the Fed think rates need to get above 6%,” Sheets said.
Behind the scenes, Fed officials will be debating whether the U.S. economy is going to go back to the “low inflation, low interest rate” environment seen before the pandemic, or if interest rates will stabilize at a higher level.
New York Fed President John Williams said he thinks the economy is going to return to low interest rates.
“I think we’re going to get a real lively intellectual debate,” Sheets said.
“The markets are leaning into the view that there is going to be a clear narrative emerging” and that rates will stay at a higher level, Sheets added.
But Sheets said he didn’t expect a consensus to emerge from the Jackson Hole summit.
Meanwhile, U.S. stocks
DJIA
SPX
were lower on Friday, heading for third weekly loss, while the yield on the 10-year Treasury note
BX:TMUBMUSD10Y
fell back to 4.25%.
See also: This Fed GDP forecast has the U.S. growing 5.8% in the third quarter. No, really.
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