In speeches and public comments this week, Fed officials have agreed that a pause in rate hikes might be here — but outright rate cuts are not on the horizon. Financial markets, however, continue to expect rates to come down.
Why it matters: For the Fed's efforts to slow the economy to have full effect, the markets must believe the Fed will hold rates at a high level until inflation falls back to near 2%.
- If markets believe the Fed will eventually back off its interest rate hikes, that belief itself creates looser monetary conditions, cutting against the central bank's goals.
Where it stands: There are overwhelming odds the Fed will lower rates by year's end, according to the CME Group.
- Interest rate futures suggest a 41% chance that the Fed will slash borrowing costs by a half percentage point.
- There is a 34% chance they do so by a larger amount.
What's going on: Speaking to a crowd of economists and other central banking officials Tuesday night, Chicago Fed president Austan Goolsbee offered an explanation for the disconnect between what the Fed says it will do and what markets anticipate.
- Financial markets are more pessimistic about the economic outlook than Fed officials. A downturn — perhaps triggered by a spreading banking crisis, a potential debt default or something else entirely — could force rate cuts, even if inflation remains above target.
- Markets "don't think the Fed will stick to getting rid of inflation. That's a dangerous way to bet," said Goolsbee, who spoke to the New York Times' Jeanna Smialek alongside his Atlanta counterpart Raphael Bostic at the conference in Florida.
- Bostic said the markets have a rosier projection than the Fed of how quickly inflation will recede — a view he and other Fed officials don't agree with.
By the numbers: The S&P 500 is now significantly higher than it was before the collapse of Silicon Valley Bank in March. Since SVB failed, the index is up roughly 7%.
Be smart: For the time being, Fed officials are likely to maintain a "tightening bias" — i.e., the most likely next move would be to hike, not cut.
- The tightening bias will help maintain tight financial conditions, the undoing of which would undermine the Fed's fight to slow the economy.
- Markets, however, are not convinced.
What's next: Watch for any further clues from Fed chair Jerome Powell, who will speak alongside former Fed chair Ben Bernanke on Friday afternoon.