Federal Reserve (Fed) Chair Jerome Powell gave a short and sweet speech at the Jackson Hole Economic Symposium on August 25, but the market took it as being brief and bitter. Since then, the Institute for Supply Management released its manufacturing and services indexes. Manufacturing activity has moderated, and services activity has been shockingly strong.

We also got August’s employment situation report. In true economist fashion, I have to say that on the one hand, the report showed a still-hot labor market with payrolls expanding by 315,000 in August. On the other hand, it showed some cooling, with a rise in the unemployment rate and a rise in the labor force participation rate.

In light of this data, what will the Fed do? Who knows? Even Fed officials probably don’t know. They’re flying by the seat of their pants. Between now and the next announcement regarding the federal funds rate on September 21, we’ll get a lot of data that will inform their decision—the most important release probably being August’s Consumer Price Index on September 13. Considering that July inflation pleasantly undershot expectations, if we get another inflation reduction in August, we could at least pretend to connect the dots to extrapolate a trend toward lower inflation.

The market seems OK with allowing the Fed to hike 50 or 75 basis points (bps; 100 bps equal 1.00%) at its next meeting. The biggest risk is probably more in the Summary of Economic Projections the Fed will release at its meeting. These projections are updated at every other meeting. At its June meeting, the Fed’s median forecast was to end 2022 with a federal funds rate of 3.4% and to end 2023 at 3.8%. Those numbers will probably move up, but the big question is by how much.

The Fed wants to convince investors that it will hike and hold, but at what level? My guess is 4%, but the market is pricing in a peak rate of around 3.8% and then a series of cuts. Fed officials may need to keep saying they will hike and hold until the market actually believes them. Don’t count on clear sailing for the markets until either the Fed changes its tune or the markets stop doubting the Fed’s resolve. It’s like a game of chicken between the Fed and the markets.

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