The Federal Reserve Nears Achievement of Key Policy Goal
According to an analysis by Evercore ISI, the Federal Reserve is on the verge of achieving one of its main policy goals, which is to tighten financial conditions. While the Fed is actively using monetary levers to combat inflation, its progress is measured through various metrics such as bond yields, employment data, stock market and real estate prices, and the strength of the U.S. dollar. The Fed has even introduced its own measure called the Financial Conditions Impulse on Growth (FCI-G), which is expected to show substantial tightening of conditions due to rising Treasury yields resulting from the central bank's rate-hiking campaign.
Krishna Guha, head of global policy and central bank strategy at Evercore ISI, highlighted the impact of the recent surge in bond yields on mortgage and corporate borrowing rates, stock prices, and the value of the dollar. These tightening financial conditions will play a crucial role in the Fed's decision-making process, including whether to hike rates in September. The 10-year Treasury yield has reached a 16-year high as investors anticipate higher growth and rates, while the government plans to issue over $1 trillion in fresh debt to cover a growing federal deficit.
Evercore estimates that the shift in conditions will result in a 0.76 percentage point drag on GDP growth over the next year, followed by smaller hits in subsequent years. These projections could convince Fed officials that their efforts to slow the economy and reduce inflation have been effective, potentially eliminating the need for further interest rate hikes, even if cuts are not implemented.
While market pricing aligns with the expectation that the Fed will halt its hiking cycle after raising rates 11 times since March 2022, there are factors challenging this narrative. Recent economic data has been stronger than anticipated, as indicated by the Citi Economic Surprise Index reaching its highest level in over two years. Additionally, the Cleveland Fed's inflation forecasting model predicts a significant rise in the consumer price index for August, surpassing the central bank's 2% goal.
The Evercore strategists acknowledge the possibility of further surprises that could challenge their base case. However, they believe that the tightening of financial conditions will raise the bar for additional rate hikes and create a safe context for the Fed to cautiously hold rates steady for the remainder of the year.
Implications for New Businesses
The Federal Reserve's policy goal of tightening financial conditions could have significant implications for new businesses.
Impact on Borrowing Rates
Rising bond yields, as a result of the Fed's rate-hiking campaign, could lead to an increase in mortgage and corporate borrowing rates. This could make it more expensive for new businesses to secure loans, potentially impacting their growth and expansion plans.
Fluctuating Market Conditions
The potential halt in the Fed's rate-hiking cycle, coupled with stronger-than-expected economic data and rising inflation, indicates a volatile financial landscape. New businesses need to be prepared for these fluctuations and have strategies in place to navigate them.
In conclusion, while the Federal Reserve's policy goals are aimed at stabilizing the economy and controlling inflation, they can create a challenging environment for new businesses. The potential for increased borrowing costs and market volatility requires new businesses to be proactive in their financial planning and risk management strategies. This "hot take" highlights the importance of understanding macroeconomic trends and their potential impact on business operations.
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