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A warning from Federal Reserve Chair Jerome Powell that Fed policymakers aren’t confident they’ve raised rates enough to fight inflation prompted mortgage rates to rebound Thursday, erasing some of the dramatic pullback in rates the week before.
But the impact of Powell’s speech at an International Monetary Fund research conference was short-lived, with bond market investors regaining their appetite Friday for long-term U.S. debt and mortgage-backed securities.
Yields on 10-year Treasury notes, a barometer for mortgage rates, surged by 11 basis points Thursday, to 4.63 percent, but closed at the same level Friday. While 10-year Treasury yields finished the week 15 basis points higher than last week’s low of 4.48 percent registered on Nov. 2, rates are still well below the 2023 peak of 5 percent on Oct. 22.
Rates on 30-year fixed-rate mortgages ticked up 14 basis points from Wednesday to Thursday, to 7.55 percent, according to lender surveys by Mortgage News Daily. But like 10-year yields, mortgage rates were essentially unchanged Friday.
Speaking at an annual IMF research conference in Washington, D.C. Thursday, Powell said the Fed remains “committed to achieving a stance of monetary policy that is sufficiently restrictive to bring inflation down to 2 percent” and “we are not confident that we have achieved such a stance.”
The Fed’s preferred measure of inflation, the 12-month change in the total personal consumption expenditures (PCE) price index, has declined from 6.6 percent in September 2022 to 3.4 percent in September 2023.
But inflation “has given us a few head fakes,” Powell said. “If it becomes appropriate to tighten policy further, we will not hesitate to do so.”
Gita Gopinath, IMF first deputy managing director, outlined some of the issues that have confounded central bank policymakers worldwide.
Much of the recent cooling of headline inflation has been driven by declining energy and food prices, and the post-pandemic recovery of global supply chains helped bring down core goods inflation, Gopinath said.
“The business that still left is when you look at services inflation, where variables like wage growth play a very important role,” Gopinath said. “So in that sense, the job is not done. But this can be tricky in terms of communication, because on one hand, you see inflation all headed in the right direction. But on the other hand, you realize that this last mile will likely be the toughest.”
At 5 percent in the U.S. and 4.5 percent in the Eurozone, core services inflation remains well above central bank targets, she noted.
“It’s important to avoid premature easing of monetary policy, either through action, or through words,” Gopinath said. “Now this is going to be a challenge, because we are living in a difficult period in terms of reading the signals. We are going to see labor markets have greater slack. We are going to see unemployment rates go up. So that’s going to be a difficult message — to stand by and say, ‘Well, we have to make sure that we get the job done.’”
Ken Rogoff, the Harvard economist whose contributions to the field were celebrated at the conference, said that policymakers are negotiating “an extraordinarily difficult period” in terms of economic shocks ranging from the pandemic, wars in Ukraine and the Middle East, “radical shifts in U.S. policy” from one president to the next, and the fragmentation of globalization.
“I think you’d have to go back to the 70s to think about a period that really compares to this,” Rogoff said.
“But the thing that has surprised me — and it surprised me a lot — is how we’ve had the pandemic, global recession, rising interest rates, inflation, and we have not had a major emerging market debt crisis,” Rogoff said.
As they set policy in the future, Rogoff advised central bank leaders “to have some humility. You can’t think there’s some rule that just explains everything, your inflation targeting rule. The world changes and models, let’s face it, are particularly bad at turning points. If your model is predicting that tomorrow is going to be sort of like today — we do really well at that. But when you have a big turning point — and we might have a turning point now, because of many factors — it’s more difficult.”
In a Nov. 9 webinar exploring what central banks around the world are likely to do next year, forecasters at Pantheon Macroeconomics said that while inflation is cooling enough in China to allow for easing of monetary policy, the government is likely to rely more on fiscal stimulus in the form of debt-funded state spending than rate cuts to maintain growth.
While inflation remains well below its 2 percent target, the Bank of Japan is signaling that it’s prepared to exit its “massive easing” (a zero percent target for 10-year bond yields and negative short-term interest rates) next year if consumer demand and wages rise as expected.
Europe’s economy is “in a rut,” and Pantheon forecasters predict inflation will fall more quickly than expected and force the European Central Bank to bring the deposit rate down by a full percentage point next year, to 3 percent.
Pantheon forecasters see the economic outlook in Latin America as deteriorating, meaning “big rate cuts will be needed” next year as inflation eases and unemployment ticks up.
In the U.S., Pantheon expects the Fed to start easing in the spring as inflation decelerates in order to keep real rates — the federal funds rate minus inflation — from rising.
In their Nov. 9 U.S. Economic Monitor bulletin, Pantheon economists predicted a “soft landing” for the U.S. economy as their base case forecast for next year, with inflation heading back to target without triggering a recession. But Pantheon puts the odds of a hard landing — an “unambiguous recession” — at about one in three, if businesses react to pressure on their profit margins with big layoffs.
“In that case, inflation will fall faster and the Fed will cut aggressively, but credit and some stocks will suffer,” Pantheon forecasters predict.
The 11 increases in the federal funds rate approved by central bank policymakers from March 2022 through July 2023 brought the federal funds rate to a target of between 5.25 percent and 5.5 percent — the highest level since 2001.
Powell indicated Thursday that Fed policymakers are aware that the delayed effects of the tightening already approved could end up tipping the economy into a recession.
“We will continue to move carefully,” he said, “allowing us to address both the risk of being misled by a few good months of data, and the risk of overtightening. We are making decisions meeting by meeting, based on the totality of the incoming data and their implications for the outlook for economic activity and inflation, as well as the balance of risks, determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time. We will keep at it until the job is done.”
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