Fed Expected To Keep Target Rate Unchanged Despite Inflation Concerns
The Federal Reserve’s target rate remains in line with a neutral stance, based on TMC Research’s Fed funds model.
The Federal Reserve’s target rate remains in line with a neutral stance, based on TMC Research’s Fed funds model.
For the past two weeks, the Fed funds rate has maintained a small spread over TMC Research’s model estimate of roughly 20 basis points or less – the smallest gap in more than a year.
The low spread suggests that the Fed still has a basis for leaving interest rates unchanged at next month’s policy meeting.
By James Picerno | The Milwaukee Company | jpicerno@themilwaukeecompany.com
Inflation uncertainty has increased lately, but there’s still a case for expecting the Federal Reserve will keep its target rate steady at a 4.25%-4.50% range for the upcoming policy meeting on Mar. 19.
Meanwhile, TMC Research’s model currently estimates a neutral rate of 4.17%, or just 16 basis points below the current 4.33% median effective Fed funds rate (EFF). Today’s model estimate is essentially unchanged from recent updates of the model. The near alignment between the model estimate and the median EFF implies that the policy rate is roughly in line with a neutral rate and therefore appropriate for current conditions. (The model uses several factors, including consumer inflation, the unemployment rate and economic activity.)
Although the model’s Fed funds estimate has remained relatively stable, uncertainty about future inflation has increased, based on the latest consumer surveys. The University of Michigan’s consumer poll for this month reports a hefty rise in the year-ahead inflation outlook to 4.3% from 3.3% in January – an outlook that’s now more than double the Fed’s 2% inflation target. Another survey of consumers conducted by the Conference Board this month tells a similar story for the average estimate of inflation over the next year.
To be fair, polling should be viewed cautiously. A complicating factor is the partisan bias that may be muddying the waters. The optimism on the economy that Democrats expressed before the election has dropped sharply while some measures of GOP-aligned consumers have rebounded.
Nonetheless, the Fed can’t ignore sustained increases in inflation expectations by the general public. It remains to be seen if inflation forecasts rise further and remain elevated. If that proves to be the case, hotter inflation expectations can become a self-fulfilling prophecy if left unaddressed.
The Treasury market appears unconcerned, at least for now. The policy-sensitive 2-year yield continues to ease in today’s trading, dipping to 4.08% as of this writing (late-morning on Thurs., Feb. 27). The 2-year rate is now at the lowest level since October. The implication: market sentiment anticipates no rate hikes by the Fed for the foreseeable future. Fed funds futures are also pricing in a no-change view for the next FOMC meeting on Mar. 19.
Why are Treasury yields falling at a time when progress on reducing inflation has stalled and consumers overall expect stronger pricing pressure? Worries about the economy and the labor market are possible factors that may be driving safe-haven trades that are pushing bond prices up and yields down.
Earlier today the government reported that initial jobless claims rose more than expected last week, jumping to a two-month high. Most economic data published to date, however, still shows an economy expanding at a moderate pace that’s in line with the fourth quarter’s 2.3% increase in GDP. A slowing economy is an increasingly topical discussion point, but for now there’s scant support in the data for that view.
Another model developed by TMC Research highlights the possibility that core consumer inflation – a relatively robust measure of the pricing trend – will remain mostly unchanged in the near term if not tick higher. The model’s 3.6% nowcast for the one-year change in February is modestly above the actual 3.3% rise in January.
Some Fed officials say that inflationary pressure may be picking up. Earlier this week, Richmond Fed President Tom Barkin advised that the shifting labor dynamics and a growing federal budget deficit could drive the price trend higher. “All these trends suggest we could see our tailwinds replaced by inflationary headwinds.”
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