XYLD - With Another Potentially Big Rate Hike Looming Will The Fed Heed Calls For Caution?
Summary
- Is the Fed ready to consider slowing its pace of rate hikes?
- Why the Fed will likely stay Hawkish at least for the time being.
- The Fed is likely to overshoot in its inflation fight for a simple reason: All of its data is backward looking.
The U.S. Federal Reserve is widely expected to deliver another large rate hike at its upcoming policy meeting. Greg Bonnell speaks with Derek Burleton, Deputy Chief Economist at TD Bank, about the central bank’s inflation fight and the case for caution amid rising economic concerns.
Transcript
Greg Bonnell: It is a big week for investors. We await the latest Federal Reserve rate decision. Of course, that's coming on Wednesday. Of course, just last week, our central bank, the Bank of Canada, delivered a smaller than expected hike. Now, some people are suggesting perhaps the Fed could be getting ready to slow its pace of rate increases as well. Joining us now for more, Derek Burleton, Deputy Chief Economist at TD Bank. Derek, great to have you on the program.
Derek Burleton: Happy Halloween.
Greg Bonnell: Happy Halloween, indeed. Let's talk about the Fed and what-- I mean, after the Bank of Canada last week, I'm not going to assume that the Bank of Canada is going to be that influential on the Fed. But it did get people talking about next steps.
Derek Burleton: The tail wagging the dog, I think. Yeah, I mean, the whole pivot narrative is out there. I think what started it was the Fed. Fed officials the week before, small but growing numbers suggesting that the Fed needs to be bringing a little bit more caution or soon to around rate hikes. And so that got -- that sort of pushed it to a new level. And then the Bank of Canada last week made global news when it cut by 50 rather than 75, and I think some --
Greg Bonnell: Or hiked by 50.
Derek Burleton: I'm sorry.
Greg Bonnell: We're so used to rate cuts, aren't we? I do the same thing. I do the same thing.
Derek Burleton: Maybe we'll talk about rate cuts later because we do see some coming, but yeah, hike, absolutely. And yeah, I think it just reinforces some of this narrative. So it'll be interesting. I'm not thinking so much that we're going to see a major Fed pivot at least on Wednesday. I think there are a number of reasons that they're going to be cautious I think in part because the data -- the US economy is bending. It's not breaking. We saw that in third quarter GDP. We haven't really seen any slowdown in the job market. I know those numbers are coming at the end of the week, but markets are still expecting another big payroll gain and -- in October.
And I think one of the things that the Fed's going to be concerned about, we saw a big rally in bond yields last week. That's a loosening in financial conditions. That kind of runs counter to what they're trying to achieve. So if they start to go too early, they have a big impact on global bond markets, that could be something that could come around and bite them later. So I think you add it up, and I think Powell and the statement itself are going to remain quite hawkish.
Greg Bonnell: It sounds like central banks are in a tough position, as you mentioned, like the markets will react off the smallest piece of information. And then perhaps that's not what the Fed wants to see in terms of financial conditions, so they have to try to worry about, OK, going forward if we don't take some reflection as to what we've been doing already, how big of an impact will it have on the economy a year from now, 18 months from now? But if we stop too early and then inflation doesn't get under control, it doesn't sound like an enviable task at this moment.
Derek Burleton: No, it isn't. And hearkened back to the 70s where inflation fell back, then it jumped up again. A little bit of focus on Australia where they went from -- they dialed back rate hikes, and all of a sudden the inflation numbers really broke out in the next two months. And who knows what they're going to -- the challenge they're going to be faced with. So yes, it's not an easy challenge. I think they still have their focus on inflation. The latest signs of inflation, we had the September spending data last week, and that's their preferred measure of inflation and still remaining stubbornly high.
The one positive thing we saw last week was wage growth maybe starting to roll over a bit, but it's too early to say. But all that, yeah, I think they're going to lean on the side of caution on that front, and I think the markets will have to extrapolate. And I think by December they're probably going to be in a position.
The difference with the Fed and the Bank of Canada is the fact that we hear from Fed officials all the time. They're out there talking, and they have plenty of time and a lot of data between now and December to start realigning that ship. So something I don't think Powell will do much of this week, but there's going to be plenty of opportunity to begin as we move into December. And I do expect a bit of a dialing back then that they'll have a chance to get in there and affect market thinking.
Greg Bonnell: You mentioned wages there, and that seems to be the key one, right? Because at first you would say, well, why do we have this red hot inflation? Because we have energy prices, because of this, because of shipping container costs. And we've all seen the graphs and the charts that are quite dramatic in terms of how much energy prices will come down, how much shipping costs have come down. But then that inflation just started working its way through the economy into the services. Is that the real trick now to -- as it enters that area of the economy to say, how do we get at that?
Derek Burleton: Yeah, I think that's the big one. Until wage growth really begins to pull back more noticeably, they're faced with a challenge. And for that to happen, we've got to see some slackening in the job market. So not just the October employment data out on Friday out of the US is key. We also get this report that now is gaining almost household notoriety. It's the JOLTS data, but that's lagged a month. So what that data tells us is job vacancies. That's the labor turnover survey, and that comes out earlier this week. And that'll give us a sense, as of September, how many job vacancies were there. And we did see the last month, the excess demand and the job market is beginning to roll over a bit. So some early signs just hasn't shown up in that payroll data that has more of the official stat, but that will come out earlier. And I think the two together we'll be looking at this week to see, OK, are we starting to see some evidence of the job market slowing?
Greg Bonnell: Now we need to listen to the central bankers speak, whether it's ours, Tiff Macklem, or south of the border, other Western countries. The playbook seems to be now, listen, we need to raise interest rates to tame inflation. Then once we get there, at some point, we will pause. But then we're going to hold it there for a long time to make sure that we have the situation under control. Now, that's what they would like to do. What do we think they might have to do? And really what I'm trying to get at is when do they start cutting again?
Derek Burleton: It goes back to my first point. No, yeah, and I do think there's a good chance they're going to overshoot. I don't think I'm going to be alarming too many people by saying that. They're basing their rate decisions on backward-looking data to some extent or have been, and now the Bank of Canada has begun to pivot. They're building in more some of the current spending slowdown, which is more of a leading indicator of inflation into their calculus. The Fed hasn't done that yet. They're still very much focused on inflation, which is really evidence of activity that happened six months ago. So yeah, I mean, that's really the thing, and I think that's the one thing. We'll see that'll be the noticeable shift.
And to the point about cut rate cuts, yeah, it's not going to happen very quick. I think by, we get to mid-2023, I think we're going to start seeing clear evidence that they've overshot. The economy will have been softer. That's when inflation is really going to begin to pull back, start to see more pullback and wage inflation, and that's where they're going to set them up for rate cuts. We have the Bank of Canada cutting rates by a full percentage point in the fourth quarter of next year, more than the markets are pricing and the Fed cutting by less but still looking to cut rates, and the markets will be pricing that in earlier.
For further details see:
With Another Potentially Big Rate Hike Looming, Will The Fed Heed Calls For Caution?