The Fed can rest easy. Monetary conditions tightened bonds for him


The autumn meeting of the US Fed did not bring about a change in the setting of interest rates. As expected, the US central bank kept the main interest rate at the highest levels since 2001, where it raised it this year during the holidays. At the same time, it is not excluded that monetary policy will be further tightened at one of the next meetings.

Favorable data on the development of the US economy support expectations that the US central bank will not be in too much of a hurry to loosen monetary policy. The US economy accelerated to 4.9 percent growth in the third quarter from 2.1 percent in the second quarter. That, economists say, is fueling investors’ fears that the Fed will be able to afford higher rates for a longer period of time.

While last quarter’s high growth rate is unlikely to be sustainable, it is indicative of the economy’s resilience despite previous aggressive interest rate hikes. At the same time, U.S. central bankers are sending signals to markets that rates will remain on tight levels until inflation returns toward the 2 percent target.

Consumer prices in the United States increased by 3.7 percent year-on-year in September. So-called core inflation increased by 4.1 percent year-on-year in September. Core inflation is an important indicator for the central bank. It ignores the development of food and energy prices, which tend to fluctuate, and the bank usually does not react to their movements even in normal times.

“Tighter financial and credit conditions for households and businesses are likely to limit economic activity, employment and inflation. The extent of these impacts remains uncertain. The central bank continues to pay close attention to inflation risks and will continue to evaluate additional information and its impact on monetary policy. The Committee is strongly committed to returning inflation to its 2 percent target,” the Fed said in a statement.

At the subsequent press conference, Fed chief Powell stated that the full effects of the tighter monetary policy are yet to be felt.

“The process of returning inflation to the target still has a long way to go. We are very attentive to the risks that inflation poses to our mandate. A few months of good inflation data is only the beginning of what will be needed,” summed up the head of the central bank, which is closely watched by the markets.

“We are not thinking or talking about a rate cut,” Jerome Powell emphasized.

“Reducing inflation likely requires a period of below-potential economic growth and softening labor market conditions,” Powell noted. This refers to a situation where the demand for labor decreases, or on the contrary, the supply of labor increases, which leads to a higher rate of unemployment, i.e. to a cooling of the labor market.

According to the Fed, this is what is still needed, as the current conditions on the American labor market do not yet contribute to taming inflation in the way that the central bank would like.

Bonds help

Developments in the US government bond market are also helping the US central bank tighten monetary policy. The 10-year yield attacked the 5 percent mark late last month, the highest levels since 2007.

“The Fed appears to have found a ‘helper’ in the rising 10-year yield. Various members of the Fed have expressed themselves in this way in recent days. Even Fed Chairman Jerome Powell admitted that ‘financial conditions have tightened significantly in recent months, and longer-term bond yields have been an important driver of that tightening,'” notes Kristina Hooper, chief global markets strategist at investment firm Invesco.

According to her, therefore, the Fed can afford not to raise rates further at the moment, because the markets have essentially done it for it. “The rising ten-year bond yield is probably a positive phenomenon. Because it means the Fed no longer has to raise rates, and therefore accelerates the end of the tightening cycle in my view. However, it also puts downward pressure on shares,” Hooper points out.

In October, the main US stock index S&P 500 fell more than two percent to the lowest levels since the beginning of June. Since the beginning of August, the index recorded a ten percent correction.

Photo: Trading View, List of Reports

Development of the S&P 500 stock index (blue curve) and the ten-year US Treasury bond over the past month. While stocks headed down more than two percent, the bond’s yield went from 4.65 percent to a current 4.92 percent.

The Czech National Bank (ČNB) will also decide on interest rates this week on Thursday. For the first time since the start of the coronavirus pandemic in 2020, a possible reduction in interest rates is again on the table.

The main argument for easing monetary policy is inflation targeting, which sets interest rates with regard to its future development. On the 12- to 18-month horizon of the CNB’s monetary policy, the pace of price growth should already approach the central bank’s two percent target.

However, recent comments by some members of the Bank Board suggest that there will be no interest rate cut at the November meeting after all. It should more realistically be in play at a meeting just before Christmas, or possibly at the beginning of the new year.

We have updated the text with the statement of Fed chief Jerome Powell.

The article is in Czech

Tags: Fed rest easy Monetary conditions tightened bonds


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