Last word of 2023 goes to Jay Powell

Jay hawk. Having last word doesn’t always ensure winning fight. But on Wednesday, U.S. Federal Reserve Chair Jerome Powell will try to have final say of year in his ongoing tussle with markets. central bank is set to keep interest rates stey and Powell will attempt to persue investors that aggressive rate cuts aren’t imminent despite falling inflation. If he is successful, stocks and bonds will have a tough holiday period. If he fails, Fed’s plans for next year could be derailed.

market thinks Fed will cut rates from current 5.25% to 5.5% to around 4.25% in next 12 months, according to derivatives prices collected by LSEG. Powell has different plans. He is expected to keep rates unchanged following two-day meeting with or Fed bankers, which starts today. More importantly, having missed inflationary spike on way up, he doesn’t want to run risk of cutting m prematurely.

Markets could do his job for him. Higher bond yields increase cost of borrowing, which helps to reduce consumption and quell inflation. But Treasury investors, not to be gaslit, are doing opposite, reing good economic news as a green light for rate cuts.

Against odds, U.S. economy is gliding towards a rare so-called soft landing, with inflation converging towards Fed’s 2% target without a recession. core personal consumption expenditure index, which excludes food and energy prices and is Fed’s preferred inflation measure, is running at an annualised rate of around 2.1% over past six months. And although unemployment rate is low, re are no signs of an inflationary wage spike.

Powell could lower borrowing costs next year and still cool price growth as long as borrowing costs stay higher than inflation, especially if core PCE drops to 2.6% in 2024 from 3.5% now, as Fed predicts. If markets continue to ignore Powell’s pleas, a rally in both stocks and bonds might continue. S&P 500 Index has gained 7.7% since October, including reinvested dividends, and is on track to return more than 20% for 2023. Yields on 2-year U.S. Treasuries, which move inversely to prices, have fallen from 5.2% in October to 4.7% now.

But that also makes Powell’s life more difficult. Real-world rates are not dictated just by what Fed would like, but also by markets. As long as market yields are low, Powell can make policy and argue his case, but he will find it hard to make a difference.

Context News

U.S. Federal Reserve will announce its last decision of 2023 on interest rates on Dec. 13, following a two-day meeting. According to a Reuters poll of economists, central bank will not increase rates at meeting and will hold m stey at current level of 5.25% to 5.5% until at least July. U.S. consumer prices rose at an annual rate of 3.1% in November, in line with market expectations and slightly lower than 3.2% growth rate recorded in October, according to official data released on Dec. 12.