One chart is all it took to move financial markets on Thursday.
The President of St. Louis Fed Chairman James Bullard presented that chart as part of a presentation in Louisville, Ky., and it shows where he sees “a pretty restrictive zone” for the central bank’s main policy rate target. Bullard put the band somewhere between 5% to 7%, up from the current fed funds rate range of 3.75% to 4%. That was enough to cause investors to sell stocks and bonds together, push the dollar higher, and rewire expectations about how high interest rates might go.
Read: Fed’s Bullard says benchmark interest rate in 5%-7% range may be needed to reduce inflation
The Bullard zone was based on estimated policy levels suggested by Taylor-type rules, one with generous assumptions and the other with less generous assumptions. The “Taylor rule” is a widely accepted equation, or what former Fed Chairman Ben Bernanke described as a “rule of thumb,” developed by economist John Taylor of Stanford University as a the central bank’s policy rate should be relative to the state of the. the economy.
Currently, the current state of the economy includes an annual headline inflation rate from the consumer price index at 7.7% in October, falling below 8% for the first time in eight months. Although other inflation indicators are favored by policymakers, the annual headline CPI rate is important because it can affect household expectations.
Variations on the Taylor rule can produce different results depending on the numbers being used, and the upper range of the Bullard zone is much higher than traders and investors currently imagine. On Thursday, Fed futures traders, for example, were raising their expectations for a 5%-plus fed funds rate next year, but still not pricing in a significant chance of a 6% policy rate.
Team at Goldman Sachs Group GS,
He revised his 2023 expectations slightly higher in a new forecast this week, saying the Fed is likely to raise rates next year by between 5% and 5.25%. However, on Thursday, Bullard described 5% to 5.25% as the minimum level for the fed funds rate.
After Bullard’s presentation on Thursday, US DJIA stocks,
the New York session ended with a second straight session of losses. ICE DXY US Dollar Index,
advanced 0.3%. And Treasury yields jumped – pushing the policy-sensitive 2-year rate TMUBMUSD02Y,
up to 4.45% and the 10-year benchmark rate TMUBMUSD10Y,
A 6% fed funds rate has been a possibility since April, but has not been widely accepted by the financial markets. Softer-than-expected readings on the CPI and producer prices gave investors reasons to hope the Fed could moderate aggressive rate hikes, although money managers and economists said financial markets were weighing on the risk of inflation quickly falling towards 2% is too low. Enough.
Bullard is a voting member of the Federal Open Market Committee that sets rates this year, but drops off the voting roll in 2023.
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