Fed Rates 

Why the Fed may be all set for another round of rate hikes?

As the Fed meets over the end of the month and puts out the Fed statement on November 01, 2023, the big question is what happens to rates? The Fed meet is likely to be a fairly important one.

Bond yields and dollar index

Between the last Fed meeting and the current meet, the one thing that has really changed is the way the bond yield in the US has responded. US bond yields spiked to a high of 5% before partially retreating. However, that is one side of the story. The other is the persistent strength in the US dollar index as it is now close to 107, a level it has broken only thrice in the last 40 years. What does this spike in bond yields and the sharp rise in dollar index really imply?

Get the big story, first.

In the past, it has been noticed that the bond yields and dollar index have often been ambivalent. This is the first time that there is hawkishness seen in both these parameters. It is probably a clear indication that the Fed may have to take a very clear view shift in the upcoming Fed meeting. After 20 months of rate hikes worth 525 basis points, inflation is still about 150 bps off the target. That is not great news for the Fed. What is of greater concern to the Fed is that GDP growth is just too robust for inflation to come down. That is what the spike in bond yields and the dollar index hint at. It is about a likely shift in the Fed style.

Why would a shift happen?

The feeling in the Fed has been quite strong that somewhere along the way, the Fed has given up on inflation due to growth fears. That is a legitimate fear, but data appears to point otherwise. One has to only look at the macro data put out last week. The PCE inflation for September 2023 was static at 3.4% for the third month in a row. Clearly, the policy of waiting for the lag effect of rate hikes is not working. Secondly, the GDP growth rate of 4.9% in Q3 is a hint that growth in GDP and spending will offset most of the inflation gains. The only way is to adopt a different kind of approach to handling the current scene.

How could Fed stance shift?

It is easy to dismiss the spike in bond yields as being caused by the falling bond prices due to the sell-off. That is more of the effect, not the cause. The cause, probably, is that markets now are tending to believe that the Fed may rush through with more rate hikes. The big fear that high rates will kill GDP is not true. At least, the data has proven the same. At the same time the robust GDP growth is boosting income levels and offsetting the inflation gains. The only answer is to once again front-end rate hikes to quickly move inflation to the 2% mark. Make no mistake, the Fed is likely to try a different medicine! The Fed must, after all, still be seen as the harbinger of price stability in the US.