Markets May Do Powell’s Job For Him

By Breakingviews

Markets may give a helpful assist to the Federal Reserve. U.S. central bank Chair Jerome Powell has been speaking aggressively about interest rate hikes. The Eurodollar yield curve implies the Fed will overshoot with swift increases, which will then need to be cut. In response to expectations, investors and companies could trim spending and investing in a way that eases inflation, without Powell needing to move so big on rates.

In Powell’s most aggressive comments yet on Monday, he said that the Fed could hike in bigger steps than the 25-basis point bump last week. Further, it may raise rates beyond what is considered the neutral level at which monetary policy is neither helping nor hurting the economy. The Fed’s latest median forecast for next year’s rate is 2.8%, compared to what Piper Sandler estimates as the nominal neutral rate of around 2%.

Investors have taken notice of the big rhetorical U-turn on easy money policies. The yield curve on the Eurodollar, which can be a window into what the market thinks the Fed will do, hit a peak of 2.96% in June 2023 as of Thursday morning. But then it inverts in the second half of 2023, suggesting that investors think longer term rates will be lower than short term ones. If that plays out, that would be one of the fastest reversals after a rate hike liftoff.

The expectations could spur the decision-makers to react more quickly, reshaping the economy. Typically rate changes take months or even years to cycle through. But the Business Roundtable’s CEO outlook survey for the first quarter shows capital investment plans falling by nine points, suggesting that corporate chieftains are already pulling back spending.

Changes to sentiment are popping up elsewhere. U.S. corporate debt markets have halted activity as investors readjust their risk appetite in what could be a dramatically changing rate environment. Mortgage application volume was down 8% in the week ended March 18 compared to the week earlier, and refinancing applications were off 14% from the prior week and 54% compared to the same week a year earlier, according to the Mortgage Bankers Association.

The risk is that Powell is so aggressive in his rhetoric that the market moves too quickly. But if inflation is contained without Powell doing as much, the market could avoid the types of shocks it currently thinks are coming.

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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.