The last rate hike

Posted by Jacob Radke
July 25, 2023

The Federal Open Markets Committee (FOMC) is meeting today and tomorrow to discuss the future of monetary policy. Inflation is below 3% and the unemployment rate has remained low. The Fed targets 2% inflation and 4% or lower unemployment, by mandate.

Policy rate, inflation rate, and unemployment

The markets currently see a 98% chance of a rate hike on Wednesday and a 62% chance that there will be no more hikes past that.

The market rates lead the policy rates.

What you need to keep in mind though is that market rates lead policy rates, or policy rates lag market rates. The market is consistently disseminating the Fed’s rhetoric and posture to determine likely outcomes in future policy rates, that’s how it is leading.

Long term rates tend to trail closer to expectations around future terminal rates with their respective market maturity premium. So the ten year treasury rate anticipates the terminal policy rate to largely be around 2.5% or maybe slightly higher, as the Fed has stated.

So your investing strategy should somewhat, within reason, try to forecast the future of policy (not current policy).

Where/when will we see an impact from rates?

“Long and variable lags”, said every economist ever on the impact of monetary tightening.

This means it maybe will never be felt, be felt within a few months of rates rising, or in 2 years.

It can be assumed that markets such as the housing markets have felt the impact in virtually real time. Buyer demand has somewhat subsided and seller demand is very nearly gone.

Then things like unemployment haven’t felt the effects of tightening, yet, and they maybe won’t.

The stock market felt the impact of rates before they even happened in 2022, and have now started to look past them.

So the simple answer is I don’t know, but they will be felt sometime somewhere. Now because of that fact there are two simple things that you can use. Don’t fight the fed and you know what you know.

If you know that the housing market and stock/bond market have felt the impact of higher rates. It means the consensus on rate impacts has been made and there aren’t likely many more people who can push that side of the boat further towards that direction. Once everyone reaches some consensus on something, you can’t suddenly have more people to further extrapolate the reality that consensus was projecting. The other side of the boat or another boat may start to look attractive as the consensus starts to shift to the other side. We are seeing that with stock bearishness and cash investments. People thoughts stocks were going nowhere and now that they are going somewhere, cash investors have started to tag along with the new consensus that stocks are maybe going somewhere.

The other is don’t fight the Fed. Again, it is largely expected that the Fed will not raise rates anymore through the rest of the year, after July, if that is the case cash yields and potentially long term yields will start to lead the policy rates downward. That means less return on cash and missed opportunity in long term rates.

Know what is known, and don’t go against the grain of the Fed.

The FedNow Digital Payment Service

Since I am on the topic of the Fed I think it makes sense to bring up the FedNow service that launched last week.

The point of this to allow Americans to send and receive funds in seconds 24 hours a day, seven days a week.

Today if you want to transfer money you have to do it during bank hours and it usually takes a day or two to settle. The lag is long. With this innovation a person can send payment, a recipient can receive payment, and then send another payment all in the same day without issues, where they may have taken several days before.

The impact to the economy is the ability to increase the velocity of money, which is a metric in GDP. The faster money moves in an economy the more potential GDP has.

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