It’s not me, it’s you. Does the Fed have a credibility issue?
As widely expected, the Fed raised its benchmark interest rate 25 basis points to a level between 4.5% and 4.75% at its February 1 meeting in its continuing effort to ease stubborn inflation.
In comments following the meeting, Chairman Jerome Powell said there is still more work to do to reduce inflation, which jumped by 7.5% year over year in January. Powell strongly signaled what is likely to be another 25-basis-point increase at the next Fed meeting in late March.
Once again, however, the interest rate and equity markets reacted with a strong sense of doubt that the Fed would, indeed, continue to increase rates. The result was a short-lived rally in equity and interest rate markets, with two-year Treasury rates decreasing by 10 basis points to 4.1%.
But just two days later, startling news that 517,000 new jobs were created in January and unemployment had dropped to 3.4% brought expectations back to normal, with two-year Treasury rates rising by 35 basis points.
“This isn’t the first time financial markets have responded to the Fed’s guidance with disbelief,” said Jeff Milheiser, vice president, Funding & Investments in the Treasury group at CoBank. “The reaction is odd because the Fed has gone to great lengths to explain what they’re doing and not surprise the market with unexpected moves. It does, however, explain the high level of volatility we’ve been seeing, and which we continue to expect throughout 2023.”
Milheiser added that January’s strong job numbers are contributing to a sense among market participants that there is a greater possibility of a soft landing from what has been a 40-year high for inflation. A soft landing is defined as a slowing of economic growth prompted by higher interest rates, but with less of a negative impact on employment.
Despite this sentiment, CoBank is still expecting a recession in 2023, although occurring later in the year than previously thought.
On February 14, the Bureau of Labor Statistics reported that the Consumer Price Index—one of the primary gauges of annual inflation—was 6.4% for January, the seventh straight monthly decrease.