- The stock and bond market is betting on the Federal Reserve suspending interest rate hikes, the most aggressive monetary policy since the 1980s, at this week’s Federal Open Market Committee meeting.
- Former Fed Vice Chairman Roger Ferguson told CNBC he believes the Fed’s decision is a much tighter decision than the market is expecting and that there will be further rate hikes by central banks afterwards to curb inflation.
- Investors should brace themselves for a Fed “that will continue raising rates,” he says.
Traders are signaling that a pause in rate hikes is the most likely outcome of this week’s Federal Reserve FOMC meeting, at a time when some strategists are saying a new bull market is underway. The Dow Jones Industrial Average posted three successful sessions last week, the NASDAQ Composite recorded its sixth consecutive positive week for the first time since November 2019, and all major indices closed above their 50-day and 200-day moving averages on Friday .
“The bear market is officially over,” said Bank of America equity strategist Savita Subramanian recently, noting that the S&P 500 is up 20% from its October 2022 low.
Some are questioning the new bull market statement as market leadership has been tight so far – a handful of the biggest tech stocks have been responsible for much of the recovery in market indices. But there’s another important reason why investors shouldn’t get overconfident. Even if the Federal Reserve decides to pause when it announces its latest FOMC decision on Wednesday, a prolonged change in policy from the Fed at its most aggressive period of monetary policy since the 1980s is by no means certain or warranted.
That’s according to Roger Ferguson, former vice chairman of the US Federal Reserve.
Last month, the Fed approved its tenth rate hike in just over a year, the fastest monetary tightening the central bank has undertaken since the 1980s, with a significant impact not only on stock and bond markets but also on the economy and consumers . In its May FOMC meeting statement, the Fed removed the need for “additional monetary tightening” to meet inflation targets. This has helped maintain the majority view in the market that a pause will be announced this week.
But Ferguson remains unconvinced.
“I think the break here is really a closer call than the market is currently anticipating,” he said in an interview with CNBC’s Squawk Box on Friday. And even if the Fed takes a break, Ferguson says that doesn’t mean there won’t be more rate hikes later in the year.
“The market should brace for a Fed that will continue raising rates, even if this is a pause,” Ferguson said.
He’s not the only one who thinks a Fed pause won’t last long. “We expect the Fed to skip this month but set the table for action in July,” said Michelle Girard, US chief of NatWest Markets, in an interview with Steve Liesman, CNBC’s senior economics reporter, last week.
According to former Atlanta Fed President Dennis Lockhart, a pause is very likely. However, in an interview with CNBC’s Closing Bell Overtime, he indicated that inflation will continue to be a problem for the Fed. “There are some discernible signs of decelerating inflation, but it is very slow. I think the committee still faces a major challenge, especially with a 2 percent target,” Lockhart said, referring to the Fed’s stated goal of reviving inflation and lowering it to a target corridor of 2 percent in the longer term.
Annualized inflation was 4.9% in April, slightly below the market estimate, but it remains sticky, as reflected in both prices across the economy and the expectations of many CEOs on file about the Talking about inflation will persist. The latest annual and monthly inflation trend figures will be released next week. The CPI report for May is due out on Tuesday, the first day of the Fed’s two-day FOMC meeting.
Traders react as Federal Reserve Chairman Jerome Powell delivers his remarks on a screen on the trading floor of the New York Stock Exchange (NYSE) May 3, 2023.
Brendan McDermid | Portal
Continued concern about inflation is one of the factors leading Ferguson to see a higher likelihood of a rate hike next Tuesday. This assessment is supported, among other things, by the continuing tight labor market. Wage growth has cooled and unemployment is rising. But Ferguson said there are about 1.7 to 1.8 jobs for every unemployed person, which is well above the norm; and wages, which have continued to rise, not only in the latest national data, but also in terms of what he anecdotally hears from CEOs — Ferguson serves on the boards of several large companies, including Alphabet and Corning.
“I think the overall picture is one of inflation and inflationary pressures higher and more persistent than the Fed’s target figure of 2%. So I think it’s the data that’s already out there that is pointing us towards more rate hikes,” he said.
Others see the recent slowdown in the labor market as a sign that the Fed may soon be tapering its rate hike strategy more sharply. Wharton professor Jeremy Siegel recently told CNBC that while the Fed has expressed a strong commitment to bringing inflation down, the central bank’s dual mandate is to meet its target inflation rate and encourage maximum employment. By historical standards, unemployment remains extremely low at below 4%, but jobless claims recently hit their highest level since October 2021.
“I’m talking trend here,” Siegel said.
For now, the Fed “can be as aggressive and restrictive as it is,” Siegel said, as unemployment has not increased significantly and workers remain confident about their job prospects. There are some signs that worker confidence is declining. The latest reading of the Conference Board’s Consumer Confidence Index showed that May’s consumer assessment of current employment conditions experienced “the most notable deterioration” of consumer sentiment data tracked. Labor economists told CNBC that the latest data from the overall jobs market supports Fed Chair Jerome Powell’s view that the central bank can bring about a soft landing for the economy.
“There’s nothing here that makes me think we’re not in a soft landing scenario,” Rucha Vankudre, senior economist at employment consultancy Lightcast, said in a recent interview following May’s nonfarm payrolls report. “I wouldn’t be surprised if the Fed decided to leave interest rates where they are. All indicators point to the economy going in the right direction.”
Nick Bunker, director of economic research at Indeed Hiring Lab, says all of the current data points are broadly consistent with the soft landing hypothesis. “The overall picture here shows that the labor market is cooling down over the long term. There are signs of moderation and not many red flags,” Bunker said.
But there’s an old saying on Wall Street that the job market is always the last to know when a recession hits.
“Let me say one thing,” Siegel told CNBC. “If we get a negative job report within the next month, next two months, it will make headlines for the first time since Covid. And then people will say, ‘Oh, can I be sure I’ll get that?’ different work?’ And that’s going to affect politics and I think it’s going to put pressure on the Fed on the other side, and then they’re going to start saying, ‘okay, maybe inflation will get better.’
Goldman Sachs recently downgraded its rating on the likelihood of the US economy slipping into recession, but its own CEO David Solomon – who remains convinced higher inflation will be sustained – and Ferguson disagree sure how future Fed decisions will affect the economic outlook. Solomon said at the recent CNBC CEO Council Summit that “some structural things related to inflation” will make it difficult to “easily” return to the Fed’s 2% target, and even if the Fed pauses, based on that What He Sees Now The economy isn’t expected to cut rates until year-end — an outcome bond traders have been betting on.
Ferguson worries that high inflation could force the Fed to raise interest rates to levels that will effectively push the US into a recession. “I still think recession is a real possibility. Briefly and superficially, you hope, but you know, let’s see and hope that Goldman is right,” Ferguson said.
Former Fed Governor Frederic Mishkin shares inflation concerns and believes the right course for the Fed is not to pause in June.
“I can understand why [the Fed] may want to [pause]”It doesn’t matter if they do,” Mishkin said in a recent CNBC interview. “But I think we’re in a situation where the inflation numbers are still high and very slow to approach the 2 percent target.”
Mishkin is more concerned, he said, about underlying inflation, a number that can reliably predict what inflation will look like going forward. “The economy and jobs are still strong, there is some moderation, but we still have a long way to go before we can contain inflationary pressures, so I think the Fed needs to raise rates, and do it better now if we do that to show their strong commitment to keeping inflation under control,” he said.
A pause is unlikely to do significant damage to the economy, even if subsequent rate hikes are needed, Ferguson said, citing examples of “early pauses” – the Bank of Canada and the Reserve Bank of Australia. “Both have taken a break and have now returned to the wandering process,” he said.