The Fed finally achieves long-term interest rate moderation. Will investors believe them?
Tiana Lowe
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Buried in Jerome Powell’s comparatively banal announcement that the Federal Reserve would be raising interest rates by a quarter of a percentage point came the real revelation. Even after the spectacular collapse of Silicon Valley Bank, not one voting member of the Federal Open Market Committee anticipates interest rates falling below 4% next year or 3% in 2025.
SVB collapsed specifically because, betting the Fed would keep interest rates near zero and continue quantitative easing indefinitely, it sunk short-term deposits in long-term Treasurys with low but guaranteed returns. The catastrophe is not that the puerile Californians who ran and banked with SVB believed this but rather that everyone from Wall Street to the Hill to the Eccles Building that houses our central bank itself thought that an endless zero interest rate policy was possible.
JEROME POWELL’S PAUL VOLCKER MOMENT
Let us dig back into past editions of the Fed’s Summary of Economic Projections, periodic surveys detailing the expectations of meeting participants. Consider that in July 2021, when the consumer price index showed inflation was already 5.4%, the Fed anticipated that interest rates would remain in the 0% to 0.25% range for both 2022 and 2023. By December, when the CPI showed inflation hitting 7%, the Fed thought interest rates would only need to reach 1%. Only in March of last year, when inflation was 8.5%, did the Fed finally raise rates from near-zero by a mere 25 basis points, citing Russia’s invasion of Ukraine and anticipating that rates would only need to reach 2% for the year median.
It took a while, but the Fed woke up. Suddenly, Fed whisperers were publishing pieces telegraphing Powell’s reawakened ambition to channel Paul Volcker, and former doves like Neel Kashkari publicly owned their reincarnations into hawks. The easiest explanation for the about-face is that the Fed, as practitioners of the science of monetary policy, understood that unfettered ZIRP and quantitative easing had failed. But the rest of the financial class were religious adherents who had banked their fortunes on the lie of free and easy money.
Investors first predicted, like the Fed, that inflation was transitory. Then, unlike the Fed, they continued to anticipate the ephemeral pivot, which the latest Summary of Economic Projections from the central bank makes clear is not coming in any real sense. The FOMC consensus is that the median federal funds rate will be 5.1% for this year, 4.3% for the next, and 3.1% for 2025. As with nearly all SEPs, it predicts that rates will be 2.5% in the long term, but unlike the predictions of the ZIRP era, this time, the Fed actually means it.