All Eyes On Powell
That will give us the context to evaluate whatever Powell and the Fed say tomorrow. Expect a 50 bp hike and continued hawkish commentary. But watch closely Powell’s response to the most recent data and any comments he makes about U.S. debt markets. That will be the best indicator of the fed funds rate going forward.
Right now, the yield on the 10-year (at around 3.5% as I write this) is signaling inflation should be down to between 2% and 3% by the end of the year, which, as noted, is consistent with market expectations. If that is the case, then the fed funds rate will, based on past behavior, be constrained to a maximum of around 5%, even if we move back to the spreads we saw in the 1990s. Even if we move to a more historically normal monetary policy stance, the inflation data and the Fed’s historical performance show that the fed funds rate will likely peak early next year.
That will be the key thing to watch: whether the Fed signals it is close to the peak. I doubt it, as Powell wants there to be no doubt about the Fed’s determination to bring inflation down. Even if it does not, we can learn a lot by watching the 10-year Treasury yield because the Fed certainly is as well, even if it does not say so.
Brad McMillan is the chief investment officer at Commonwealth Financial Network.