Markets (bonds, equities and currencies) got very excited yesterday when the rise in US payrolls slowed again in December, with equities up, bond yields down, and the US$ lower. Plus wage inflation has slowed. And the ISM indicators suggest the economy is slowing. So, the thinking is that the Fed will be able to stop raising rates, soon. And it is true, as the chart below shows, that employment growth is steadily slowing, and the average ISM continues to fall.
The impact on the economy of the sharp rise in interest rates over the last year has yet to be felt. Economies respond to rising interest rates with a lag, often as long as 12 months. So the rise in the Fed Funds rate is only just getting traction now. Even if the Fed stopped rising interest rates now, the economy would go on falling for many months more. And the Fed has strongly hinted that it hasn't stopped raising rates.
If I were the Fed, I would not raise rates any more. In my judgement, more than enough tightening has been transmitted to the system. Any more would risk overkill. But I am not the Fed. And there is precedent for monetary tightening being unwound too soon, requiring even bigger rate rises later on (1975 - 1979, for example).
So, when will the Fed stop raising rates? In all probability, when core inflation is falling and is much closer to 2%, and (possibly) when month-on-month payrolls growth slips below zero. In other words, not yet.
I may be wrong. It's entirely possible that at this month's Fed meeting, the committee will decide to pause the rate rises while they wait for extra data. The question for shares, though, is how willing investors will be to look through the recession towards the airy uplands of recovery in 2024.
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