The big improvement in the consumption deflator should have given the Treasury market ample reason to stage a big rally into this week’s Fed meeting. But Treasury yields are proving resistant to the downside.
It unlikely that the Fed will be able to cut rates in 2023. The labour market is proving far too resilient, despite the cuts in technology. If the economy normalises at a 5% federal funds rate, without a recession this year, this will pull up the rest of the yield curve. Treasury yields across the curve may shift back up towards 4% as a result.
The economy is not in the same place it was before the pandemic. The labour market is a lot tighter. The stimulus from investment in green energy is a lot larger. The current, higher level of nominal, and real, interest rates may be here to stay for longer.
It is telling that, even with a 30-year fixed rate mortgage average of 6.13%, the US housing market is showing signs of stabilisation. Mortgage applications for purchase have bounced off the recent lows. Lumber futures are rallying.
The Fed will likely acknowledge the progress made in the fight against inflation, but at the same time double down on its ‘higher-for-longer’ approach. They could also set the ground for adjusting higher their longer run estimate of the federal funds rate, at their next SEP in March, which at 2.5%, looks too low.
