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The Fed is not going to increase the inflation target from 2% to, say, 3% or 4%, see also Powell’s response below from the press conference on Wednesday.
GRADY TRIMBLE. Thank you, Mr. Chair. Grady Trimble with Fox Business. You’ve reiterated today and the Committee has reiterated its commitment to that 2% inflation target. I wonder, is there ever a point where you actually reevaluate that target and maybe increase your inflation target if it is stickier than even you think it is?
CHAIR POWELL. That’s just — changing our inflation goal is just something we’re not — we’re not thinking about, and it’s something we’re not going to think about. It’s — we have a 2% inflation goal, and we’ll use our tools to get inflation back to 2%. I think this isn’t the time to be thinking about that. I mean, there may be a longer run project at some point. But that is not where we are at all. The Committee, we’re not considering that. We’re not going to consider that under any circumstances. We’re going to — we’re going to keep our inflation target at 2%. We’re going to use our tools to get inflation back to 2%.
For more, see also the Fed’s official transcript from the press conference here.
See important disclaimers at the bottom of the page.
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Source: Apollo Chief Economist See important disclaimers at the bottom of the page.
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The FOMC raised the Fed funds rate to 4.5%, and their forecast is that they will raise rates 75bps in 2023, likely 50bps at their next meeting in February and then 25bps in March and then keep the policy rate flat for the rest of the year, see the first chart. The bottom line for markets is that we are getting closer to the peak in the Fed funds rate, which historically has been associated with a rally in equities and credit, see the second chart.
Source: FRB, Apollo Chief Economist 
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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I will be on Bloomberg TV today at 8:30 am to preview the Fed meeting. Inflation continues to trend lower, which is good news for the Fed and markets. But the level of inflation at 7.1% is still significantly above the FOMC’s 2% inflation target. As a result, the Fed today is likely to argue that rates need to remain high for an extended period to ensure that inflation gets all the way back to 2%.
Source: Bloomberg, Haver Analytics, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Survey response rates for employment and inflation have declined significantly during the pandemic, and this is introducing substantial measurement errors and uncertainty, see chart below. One such example is the widening gap between the establishment survey and the household survey in the employment report, with the establishment survey showing 2.6 mn jobs created over the past eight months and the household survey showing no job growth over the same period. Whether the economy created no jobs or 2.6mn jobs over the past eight months is obviously extremely important for the Fed and financial markets.
Source: BLS, Apollo Chief Economist See important disclaimers at the bottom of the page.
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During the pandemic, the Fed expanded its balance sheet by $5trn, and the Fed is now shrinking it by $95bn every month with $60bn in Treasuries and $35bn in mortgages, see the chart below.
The implications for markets of QT are the opposite of what they were for QE. The idea with QE was to lower rates, boost equities, and narrow credit spreads. With the Fed now in tightening mode, the idea with QT is to raise long rates, lower equities, and widen credit spreads. Such a tightening in financial conditions helps increase the costs of capital and ultimately slow down inflation, see also this Fed paper, which finds that shrinking the Fed balance sheet by $2.5trn is equivalent to increasing the Fed funds rate by half a percentage point.
There are a lot of opinions in financial markets about the effects of QT, but the Fed’s view is clear: Even if the effects of QT are the opposite of QE, the negative effects on the economy and markets of QT are smaller than the positive effects of QE simply because QE normally comes quicker and bigger than QT. In other words, the fact that QT is drawn out over a much longer period than QE is spreading out the negative effects over a longer period.
The bottom line is that the Fed, with rate hikes and QT, is tightening financial conditions, and the Fed’s intentions are clear: higher long rates, lower equities, and wider credit spreads. But because these effects are spread out over a longer period than when the Fed is doing QE, the negative effects of QT on markets and the economy are smaller than the positive effects of QE.
For more, see these Fed papers here, here, here, and this paper by Caballero and Simsek.
Source: FRB, Haver, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Stiglitz: The Causes of and Responses to Today’s Inflation
https://rooseveltinstitute.org/wp-content/uploads/2022/12/RI_CausesofandResponsestoTodaysInflation_Report_202212.pdfBIS: The global foreign exchange market in a highervolatility environment
https://www.bis.org/publ/qtrpdf/r_qt2212f.pdfHow does the Consumer Price Index account for the cost of housing?
https://www.brookings.edu/blog/up-front/2022/05/18/how-does-the-consumer-price-index-account-for-the-cost-of-housing/See important disclaimers at the bottom of the page.
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The weekly data for office occupancy rates shows that New York City office use after Thanksgiving reached a post-pandemic high of 50% of capacity, see chart below. Our collection of daily and weekly indicators for the US economy is available here.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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As the Fed starts to approach the peak in the Fed funds rate, the market narrative is changing from “there is a high level of uncertainty about inflation and how high rates will go” to “inflation has peaked and we have a better idea about where rates will peak during this cycle,” see chart below. This ongoing transition in the market narrative has important consequences for rates, credit, and equity markets, including levels of implied and realized vol.
Source: Apollo Chief Economist See important disclaimers at the bottom of the page.
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The Fed has clearly communicated that they want to downshift next week from 75bps to 50bps, and as we approach the peak in the Fed funds rate, we should begin to see capital markets reopen again, and in November there was a significant increase in investment grade refinancings and M&A/LBOs, see chart below.
Source: S&P LCD, Apollo Chief Economist See important disclaimers at the bottom of the page.
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