As the Fed meets this weekend for their annual summit at Jackson Hole, investors are most focused on whether rate hikes will continue and the state of the neutral interest rate.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Corporate Credit Research at Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, August 25th at 2 p.m. in London.
The eyes of the market will be on Wyoming this weekend, where the Federal Reserve is holding its annual summit at Jackson Hole. While many topics will be discussed, investors are particularly focused on two: is the Fed done raising interest rates? And is the so-called neutral rate of interest higher than initially thought?
The Federal Reserve has been raising interest rates at the fastest pace in 40 years to try to get rates to a level where economic activity starts to slow, easing inflationary pressure. But the level of interest rate that achieves this is genuinely uncertain, even to the experts at the Fed. We believe that they'll feel increasingly comfortable that rates have now hit this level. And in turn, Morgan Stanley's economists do not expect further rate hikes in this cycle. A few things drive our thinking.
First, those inflationary pressures are easing. Two key measures of underlying inflation, core PCE and core CPI, slowed sharply in the most recent reading. Leading indicators for car prices and rental costs, which have been big drivers of high inflation last year, now point in the opposite direction. Bank loan growth is slowing and the torrid pace of U.S. job growth is also moderating, two other signs that interest rates are already restrictive.
Historically, the Fed being done raising interest rates has been supportive for markets. But the relationship with high grade bonds is especially notable. Since 1984, there have been five times where the Fed has ended interest rate hiking cycles after multiple increases. Each time the yield on the U.S. aggregate bond index peaked within a month of this last hike. In short, the Fed being done has been good for the U.S. Agg Bond Index.
And we can see the logic to this. If the Fed has stopped raising interest rates, one of two things may very well be true. First, it stopped at the correct level to support growth while also reducing inflation, and that stability with less inflation is liked by the bond market. Or it has stopped because rates are actually too high and set to slow growth and inflation much more sharply. In the second scenario, investors like the safety of bonds.
But behind this question of whether the Fed will pause is another, larger issue. What is the so-called neutral rate of interest that neither slows nor boosts the U.S. economy? During the decade of stagnation that followed the global financial crisis, weak growth led people to believe that this balancing interest rate was extremely low. There are signs this thinking persists, when the Fed surveys its members about where they see the Fed funds rate over the long run, which is a proxy for where this neutral interest rate might be, the median is just 2.5%. In 2012, the Fed thought this same rate was over 4%.
So that will be another focus at Jackson Hole, and beyond. The strength of the U.S. economy in the face of higher rates has been a surprising story. Does that mean that the balancing interest rate is much higher, and will the Fed raise their long run estimates of this rate to reflect this? Or is recent U.S. strength still temporary and not yet fully reflecting the effect of higher interest rates? Expect this debate to continue in the months ahead.
Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We'd love to hear from you.
Ed Stanley: The Cutting Edge of AI
Ellen Zentner: 2024 U.S. Economic Outlook
Serena Tang: The Return of the 60/40 Portfolio
Special: What Should I Do With My Money?
Macro Economy: The 2024 Outlook Part 2
Macro Economy: The 2024 Outlook
Andrew Sheets: Will the Bond Market Suffer from Tax-Loss Selling?
Ed Stanley: Weight Loss Drugs and the Global Economy
Michael Zezas: Are the Worst Bond Returns Behind Us?
Matt Cost: How AI Could Disrupt Gaming
Mike Wilson: Will the Equity Market Rally Last?
Andrew Sheets: Upgrades and Downgrades in Corporate Credit
US Economy: What Generative AI Means for the Labor Market
Michael Zezas: What the New U.S. Speaker Means for Markets
U.S. Housing: The Impact of High Mortgage Rates
Mike Wilson: 2023 Stock Market Comes Full Circle
Andrew Sheets: Optimism in Corporate Credit
Asia Equities: China’s Risk of a Debt Deflation Loop
Vishy Tirupattur: Implications of the Treasury Market Selloff
Matthew Hornbach: The Impact of Policy on Bond Markets
Create your
podcast in
minutes
It is Free
The emPOWERed Half Hour
Now, What’s Next?
Access and Opportunity
At Scale: A Sustainability Podcast