Both the PPI (Producer Price Index) and the CPI (Consumer Price Index) were higher than expected this week, showing that inflation is still persistently high. Markets continue to worry that high inflation will drive the Fed Funds rate higher, heightening recession risks. The question remains, how high will interest rates go?
One widely regarded market forecast for the Fed Funds rate is the 2-year Treasury note. This measure rose about 0.2% for the week to 4.5%, implying that the Federal Reserve will make two more interest rate hikes, most likely 0.75% at the Fed’s November meeting and another 0.50% at the December meeting. As we have discussed previously, the market anticipates these hikes, so current stock and bond prices and interest rates already reflect this expectation.
The interest rates on longer term treasuries are lower than short-term interest rates, showing that the bond market is expecting the economy to slow, and expecting interest rates to decline over time. The 10-year treasury ended the week at 4.03%.
Given the lower long-term rates, could the Federal Reserve be done raising rates at their December meeting? There is growing evidence that this could be the case and that interest rates in the market could already be peaking. Remember, the Federal Reserve does not control all interest rates in the market. The Federal Reserve controls the Federal Funds rate, which influences other rates. According to bankrate.com, the average 30-year mortgage rate topped 7%, and has already thrown the real estate market into a recession.
Ultimately, the Federal Reserve will be data driven and needs to see inflation coming down before ending the tightening cycle, but it likely that the Federal Reserve will at least pause after the December meeting. A clear direction on interest rates, and an end to the tightening could be a significant positive for both stock and bond markets. Until we do get a clear direction there is likely to be more volatility like we saw this week.