Fed Chair Jerome Powell has his “comeuppance,” and it came courtesy of the bond market.
Bond traders boosted the 10-year Treasury yield from 2.85% at the May FOMC meeting to 3.46% on June 14. That rally forced the Fed’s hand. The Fed hiked the fed funds rate by 0.75 basis points to 1.25-1.75% on June 15, the largest increase since 1994. The hike occurred despite the Fed’s earlier guidance for 0.50 bp increases in June and July.
Traders believed the Fed was out of touch with inflation realities and the surge in yields is incontrovertible evidence that bond markets had zero faith in the Fed’s inflation outlook. The May inflation report reinforced the view.
The FOMC released its updated Summary of Economic Projections. Policymakers are predicting another 1.7% hike in interest rates by year-end. If accurate, fed funds would finish the year in the 3.4% range. In March, the esteemed FOMC members predicted a year-end rate around 1.9%. The US economic growth forecast was downgraded and surprise, surprise; they raised their inflation prediction to 5.2% from 4.3% in March.
The key takeaway from the June 15 meeting is it’s a throwaway.
The Fed has no better grip on the economic and inflation outlook now than last October. They know the labor market is tight but do not understand why employers can’t find workers. They know inflation is high and blame the Russian/Ukraine war, supply chain disruptions, and China’s covid outbreak for elevating prices. They also know that none of the above will be issues next year, so inflation will fall to 2.6% in 2023 and 2.2% in 2024. To some analysts, the Feds forecasts are questionable.
Traders, economists, and the private sector are becoming more and more skeptical of government institutions, and with good reason.
The Fed isn’t the only central bank where inflation is soaring, and policymakers have gone for an extended lunch. Turkey is the poster-child for incompetence. President Erdogan commandeered monetary policy and slashed interest rates to lower inflation. It didn’t work and the statistics institute, TUIK, reported inflation was 73.5% in May.
El Salvador President Nayib Bukele’s approach is different from Mr Erdogan’s and just as successful. His government made bitcoin legal tender in September. Since then, El Salvador has bought 2301 bitcoins for $103.0 million. They are worth $50.0 million as of June 15, which is a bit of a hit for the fourth poorest country in North America.
The Reserve Bank of Australia ( RBA) Governor Philip Lowe was adamant that Australian interest rates would remain unchanged until the latter part of 2024. In May the RBA hiked the OCR rate by 0.25% and followed that move with a 0.50% hike in June. No problem. He said sometimes his comments are interpreted as promises when the remarks are merely conditional statements. The view of low rate until 2024 was because the RBA expected the economy would need stimulus to recover from the pandemic. The economy didn’t, so rates had to rise.
The Bank of Japan is risking its credibility as Governor Haruhiko Kuroda defiantly sticks to its ultra-easy monetary policy. The overnight rate is negative 0.10%, and in April, the BoJ promised to buy an unlimited amount of 10-year Japanese Government Bonds (yield curve control policy or YCC) to ensure rates stay low. Bond futures traders are taking a run at the BoJ in anticipation that rising Japanese inflation, and a weaker currency will force the BoJ to end YCC.
Canadians are not immune. Bank of Canada policymakers and Fed officials are neck and neck in the “missed the inflation” race. The BoC hiked June 1 by 0.50%, and after comments by Deputy Governor Paul Beaudry, analysts predicted a 0.75% hike at the July 13 meeting. The Fed essentially confirmed such a move with its 0.75% hike on June 15.
The pandemic underscored the shortcomings of globalization. Covid containment measures disrupted travel, shut-down retail businesses, and closed production facilities. Those decisions reverberated throughout the G-10 economies, and soaring inflation is just one effect.
The central banks had their version of globalization. Monetary policy statements from the likes of the BoC, Fed, BoE, RBA, and ECB were not quite cut and paste jobs, but were eerily similar. Their forward guidance, blamed supply chain disruptions for higher prices, and all repeated that gains were transitory.
Fortunately, bond traders took them to task. They called out policymakers for not addressing rising inflation risks by driving the US 10-year Treasury yield to an 11-year peak. It was a bond trader coup d’état.
All hail the bond traders.