Don’t look now. The Fed could change course.
It is not elegant, graceful or sophisticated. And it appears to contradict employment and inflation data over the past 10 days, which appear to support an increase in the federal funds rate in November or December. But Federal Reserve officials have gone out of their way to downplay the likelihood of another rate hike, largely because the bond market has done the central bank’s job.
The inverse relationship between bond yields and stock prices persisted last week. After a steady rise since late summer to nearly 5% in the yield on the 10-year U.S. Treasury note — and several consecutive weeks of losses in major stock indexes — yields reversed and stocks recovered.
The S&P 500 index ended the week up 0.45%, the Dow Jones Industrial Average gained 0.79% and the Nasdaq Composite slipped 0.18%. The 10-year yield fell 0.16 points to 4.63%.
The catalyst for the about-face was a series of Fed speakers who acknowledged that the rise in bond yields had led to tighter financing conditions, leading to higher borrowing costs for businesses, consumers and the U.S. government.
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“I will be cognizant of the tightening of financial conditions caused by higher bond yields and will keep this in mind as I assess the future path of policy,” Fed Vice Chair Philip Jefferson said Monday, while Dallas Fed President, Lorie Logan, echoed this sentiment in separate remarks the same day. Atlanta Fed President Raphael Bostic got straight to the point on Tuesday morning. “I don’t think we need to raise rates any further,” he said. It couldn’t be clearer.
It makes a lot of sense. Higher bond yields are likely to slow the economy and curb inflation, they say. And if the inflation rate falls, the real or inflation-adjusted federal funds rate will effectively rise, even if the Fed doesn’t raise its target.
“Fed officials are trying hard to signal that they are done for now,” said Tom Porcelli, chief U.S. economist at PGIM Fixed Income.
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The market also thinks so. According to the CME FedWatch Tool, interest rate futures pricing now implies a less than one-third chance of another Fed funds hike this year, down from about 50/50 probability a few weeks ago. But that doesn’t mean they will fall quickly, even if the market prices in cuts of 0.75 percentage points next year. “The idea of being higher for longer periods of time is real,” says Porcelli.
That’s probably for the best. Faster Fed rate cuts than now expected in 2024 would require a worse economic outcome, hurting earnings — and the stock market.
It’s far from an all-clear signal, but a Fed that is aware of the tightening effect of the bond market is better than one that is aware of the tightening effect of the bond market. Maybe a soft landing is possible after all.
Write to Nicholas Jasinski at [email protected]