The Big Picture
For more than 100 years, the Olympic motto was "Citius, Altius, Fortius." Those Latin words translate to "Faster, Higher, Stronger." In July 2021 the International Olympic Committee (IOC) revised that motto to include the word "Communiter," which means together.
The new motto, then, is: "Citius, Altius, Fortius - Communiter."
We got to thinking about this motto because we have been struck by the Fed's Olympian mentality when it comes to raising interest rates. Since March 2022, the Fed's approach has been faster, higher, stronger - together (there haven't been any dissents at the last three meetings, all of which culminated in a 75 basis points increase in the target range for the fed funds rate).
A revision, though, now seems to be in order for the Fed based on the remarks heard from Fed Chair Powell following the November FOMC meeting.
It is no longer "Citius, Altius, Fortius - Communiter." We would submit that the Fed's new motto is "Tardius, Altius, Diutius - Communiter," which in a post-Vatican II world translates to "Slower, Higher, Longer - Together."
Out of the Block
The Fed has moved like an Olympic sprinter changing the target range for the fed funds rate, which stood at 0.00-0.25% on January 26 and is now at 3.75-4.00%. The Fed has moved as quickly as it has because it recognized in the inflation data that it remained stuck in the starting block far too long.
When the Fed finally started running in March, the Consumer Price Index (CPI) was up 8.6% year-over-year and core CPI, which excludes food and energy, was up 6.4%. The PCE Price Index was up 6.4% year-over-year and the core-PCE Price Index, which excludes food and energy and is the Fed's preferred inflation gauge, was up 5.4%.
The inflation rates have been leveling off, but as can be seen in the chart, they are not coming down in any meaningful way. In fact, Fed Chair Powell conceded at his press conference that, "There's no sense that inflation is coming down. If you look at -- I have a table of the last 12 months of 12-month readings, there's really no pattern there. We're exactly where we were a year ago."
This "sticky" inflation is what is bothering the Fed the most, yet the recent policy directive made an allowance for the idea that the lag effect of the previous rate hikes could help unstick things.
That view was captured in the following line:
"In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments."
This perspective is why the market thinks the Fed may raise rates "only" 50 basis points at its December 13-14 FOMC meeting. The latest read of the CME's Fed Watch Tool shows a 56.8% probability of a 50-basis points rate hike in December.
A Way to Go
The Fed, therefore, may slow the pace of its rate hikes, but it is still going to raise rates further. That was the implicit message from Fed Chair Powell, who said, "When (people) hear lags, they think about a pause. It's very premature in my view to be thinking about or talking about pausing our rate hike. We have a way to go. We need ongoing rate hikes to get to that level of restrictive. We don't know where that exactly is."
Separately, he acknowledged that the assessment of further tightening comes down to three questions: how fast to go; how high to raise our policy rate; and how long to remain at a restrictive level?
The market wishes there were definitive answers to each question, but there isn't at this juncture. That uncertainty is creating excess volatility around each economic release that pertains to inflation and employment since the trends in those areas are the fulcrum upon which monetary policy will pivot.
We noted above that the Fed chair isn't comfortable with where inflation sits today. He is also struck by how resilient the labor market has been, noting that the unemployment rate is still sitting near a 50-year low and that wage inflation, while flattening out, is still well above the level that would be consistent over time with 2.0% inflation.
So, there won't be a pause in the Fed's rate hikes. There are more to come, and the Fed Chair acknowledged that incoming data since the last meeting suggests the ultimate level of interest rates (i.e. the terminal rate) will be higher than previously expected. He also said that he thinks it is very difficult to make the case that the current target range for the fed funds rate is too tight given that inflation still runs well above that target range.
No one knows yet what the terminal rate will be, yet the fed funds futures market now thinks it will be 5.00-5.25% by June 2023.
The CME's FedWatch Tool indicates that the fed funds futures market assigned a 0% probability to that being the case a month ago. It is a moving target alright. To get from here to there will involve another 125 basis points worth of rate hikes, assuming that does in fact end up being the terminal rate.
What It All Means
It is not normal for the Fed to raise its policy rate by 75 basis points. The normal course of things over the past 30 years has been to move rates up, or down, in 25-basis point increments. There have been some 50-basis point moves along the way, but 75 basis points is a true outlier.
Accordingly, it says something about the Fed's race to catch up that it just implemented its fourth, consecutive 75-basis point hike and left the door open for another 75-basis point move at the December meeting.
It is moving at Usain Bolt-like speed. The difference is that Bolt won several Olympic gold medals. The Fed for its part gets a participation ribbon but is still a long way from the podium.
It will be appropriate for the Fed to slow the pace of increases and that time is coming. Those aren't our words. They are Fed Chair Powell's words. He isn't uttering any word, however, that suggests the Fed is done raising rates and considering cutting rates.
For the Fed and the market, it is "Tardius, Altius, Diutius - Communiter."
