As was expected, the Fed raised the overnight lending rate corridor by 75 basis points, to 3.0%-3.25% and in decidedly hawkish post-meeting press conference, the Chairman signaled that they are not yet close a peak in the rate. It was communicated that Fed funds would likely end the year at 4.25%. That news rocked the Treasury market with the 2-year note closing the week 32 basis points higher at 4.19%, just off the intraweek high of 4.25%. The yield curve further inverted, closing at a -57 basis points, just a shade below the -75 basis points touched in May 2000.
The best that can be said about this week, from a business perspective, is it’s over. Traders came into the week optimistic with hopes sustained from the August employment situation. We anticipated that the CPI would finally show a downtick and the relentless pressure on interest rates would finally moderate, but that did not come to pass. Instead, CPI printed an unwelcome uptick across most categories and reinforced the need for higher interest rates. While the Fed sat on the sidelines post-report, bond traders acted decisively, pushing the 2-year note 20 basis points higher on the day, ultimately ending the week 32 basis points higher.
The August CPI report was a shocker in that the expectation was for inflation to finally drift lower. In fact, the report confirmed that inflation continues to run at an elevated pace and the Fed’s raising of short-term interest rates is doing little to quell the uptick. To put it into perspective, the year-over-year rate of inflation last August was an already an elevated 5.25%. At the time, the Federal Reserve wrongly assured investors that inflation was transitory, and they didn’t need to adjust monetary policy because in short order the uptick would pass. Recall, at the time Chairman Powell was up for renomination and, we suspect, reluctant to do anything to battle rising prices, fearing that to do so would torpedo his chances for renomination. From our perspective, he had done a lousy job and should not have been renominated, but that did not come to pass.
With regard to the Fed’s action on overnight rates, our plan was to watch how consumers reacted to the July rate hike as summer progressed. We expected that high gas prices along with broad based inflation would slow consumer demand enough that the Fed would, at the very least, moderate further rate hikes, possibly even pause for a meeting or two. Instead, the Fed, via the Wall Street Journal, communicated this week that another 75-basis point hike is likely when it meets on September 21st. The various members of the Open Market Committee have all aligned as hawkish and have left open the possibility of another 75-basis point at the November meeting. That would push the overnight corridor to 3.75% to 4.00% by November 2nd. In previous communications the Fed suggested that the target rate was 3.5%, so 4% would be somewhat restrictive.
Economic data this week offered a reprieve from the recent trend of weak indicators. This morning’s employment report for August was especially cheering. Economists had been looking for the economy to add 298,000 jobs in the month, following last month’s 528,000 add. We were skeptical that August would follow with an above trend outcome, but we were proved wrong by a print of 315,000 new jobs. Ironically, bond prices rallied across the curve on the news in a case of “sell the rumor, buy the fact.” Earlier this week whisperings of an outsized employment report began to circulate. Anticipating that possibility, the two-year note yield touched 3.50% with the thirty-year yield topping out at 3.36%.
The economic data this week continued to portray a deceleration in the economy, but the most anticipated highlight was Chairman Powel’s comments at the Jackson Hole Symposium. We’ve always had a distaste for the symposium. We view it as a Davos-like affair, attended by an elite group that considers themselves above their constituents. To us, that sends the wrong message about the mission of the Central Bank. Especially given the mess the Federal Reserve has created with excessively easy monetary policy.
We’d describe the speech as being saccharine-like in the in description of the current inflationary impulse. The speech didn’t follow the post-FOMC press conference structure in which a question & answer period followed. Because of that, there were whispers that Powell would offer a mea culpa to the mess that he oversaw, but that was not to be. Instead, he painted a “Pollyanna” picture of the current state of affairs. Of that, there were 3 “jaw dropping” quotes that we need to bring to your attention. They are, in chronological order of their mention in the speech, “The absence so far of broad-based inflation pressures,” “longer-term inflation expectations have moved much less than actual inflation…suggesting that households, businesses, and market participants also believe that current high inflation readings are likely to prove transitory,” and finally, “Today we see little evidence of wage increases that might threaten excessive inflation.”