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The Macro Brief – The Fed in focus
922 Plays26 days ago
Ryan Wang, US Economist, and Dhiraj Narula, US Rates Strategist, look at the key issues facing the Federal Reserve this year.
Click here for appropriate Disclosures, including analyst certifications, and Disclaimers that must be viewed with this podcast:https://www.research.hsbc.com/R/101/JlBXX6F
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Transcript
Introduction to HSBC Podcast
00:00:02
Speaker
Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
00:00:13
Speaker
Make sure you're subscribed to stay up to date with new episodes. Thanks for listening, and now onto today's show.
00:00:33
Speaker
Hello from New York. This is the Macro Brief from HSBC Global Investment Research, the podcast that looks at the issues driving financial markets. I'm Aline Van Dyne and well, it's extremely cold and snowy here in the Big Apple.
Federal Reserve's 2026 Plans
00:00:48
Speaker
But as usual, we're in our cozy studio and today we're going to delve into the Federal Reserve's playbook for 2026. Will interest rates budge? What are the risks to the economy? And who will be the new Fed chair? And does it even matter?
00:01:04
Speaker
Here to talk about this and more are Ryan Wang, our U.S. economist and a veteran Fed watcher, and Deiraj Narula, our U.S. rates strategist. Welcome both. Thank you, Aline.
00:01:15
Speaker
Thanks,
FOMC's Policy Decision
00:01:16
Speaker
Aline. So we're speaking just one day after the Federal Open Market Committee, the FOMC had its first meeting of 2026. Ryan, let's just kick off with a quick wrap up of what happened.
00:01:30
Speaker
Well, the f FOMC, as broadly expected by market pricing, didn't make a policy rate change at this meeting. Now, of course, the context is that the Fed did deliver three 25 basis point rate cuts late last year. But now we're seemingly in a wait and see posture from the FOMC. And the federal funds target rate is just above three and a half percent.
Fed's Inflation Focus
00:01:50
Speaker
Ryan, do you think the policy rate will move this year? Our own view is that the Fed may not make any change all year long. And this has to do with, of course, the Fed's typical focus on two main elements, what's going on with inflation, what's going on with labor markets. And ah on the inflation side, we still have inflation that's somewhat elevated, running just under 3%. And then the labor market is very much a mixed picture. The unemployment rate is still historically low at just under 4.5%. But also in the past year, there's been very clear signs that job growth has slowed.
00:02:22
Speaker
Companies are not hiring as much as they were two or three years ago. Deiraj, was there a similar stability um in terms of expectations and reactions in the U.S. Treasury bond market?
00:02:35
Speaker
Yes, there was quite a limited reaction throughout the course of the FOMC announcement yesterday and Chair Powell's subsequent press conference. And as Ryan mentioned, the decision to hold policy rate steady was very well priced in by bond markets. And even if we look at near-term policy expectations that are reflected in forward bond markets, we can see that there's really little in there to challenge the guidance that came out of the FOMC meeting.
00:03:00
Speaker
As Ryan mentioned, we see both dual-sided risks to the Fed's mandate. We have seen downside risks to the labor market and upside risks to inflation. But Chair Powell did mention that both of these risks have somewhat diminished over the course of the last few months. And from our perspective, what that kind of means is that the bar for economic data releases, especially in the near term, to really move what the market is pricing is quite high now. so Bond markets are really not looking for too much by way of cuts. Across the next two meetings, there's really under a 30% chance of an additional rate cut being priced. So really not much to challenge Fed Chair Powell's wait-and-see rhetoric.
00:03:39
Speaker
So wait and see on the policy front. Now, there's also plenty of waiting and seeing in other areas related to the Fed, not least that there will be a change in the Fed chair this year.
Anticipation of New Fed Chair
00:03:51
Speaker
Ryan, just tell us where we stand, what we know, and perhaps what we don't know.
00:03:57
Speaker
Yeah, absolutely. So Fed Chair Jerome Powell's term as chair ends this May. And so markets are eagerly anticipating the announcement of the next Fed chair, the nomination for the next Fed chair.
00:04:12
Speaker
And the administration has said that there continue to be a list of four candidates and markets are waiting for a further announcement. We have candidates that include former Fed Governor Kevin Warsh, current Fed Governor Christopher Waller, financial executive Rick Reeder, as well as current National Economic Council Director Kevin Hassett. Those are the four candidates that the administration has talked about, but we haven't had clarity within that list. And is there any suggestion around timing on when this announcement might come?
00:04:46
Speaker
We have heard from the administration that an announcement in the near term is likely. The exact time frame has not been made clear, but Secretary of the Treasury Scott Besson did say this past week that an announcement could come in the next week from here, so the week following the January FOMC meeting.
00:05:02
Speaker
Okay, so something ah could happen soon. How important is that announcement? Well, historically speaking, the Fed chair has had, of course, a very large importance for the setting of monetary policy. But at the same time, it is important to remember that it is a committee.
00:05:20
Speaker
And so therefore, monetary policy is set by the entirety of the views of the policymakers. Even at the January FOMC meeting, the vote was 10 to 2. So 10 policymakers voted for no change in rates and two policymakers dissented in favor of a rate cut.
00:05:38
Speaker
And so as we go through the course of this year and as we finally see who the new Fed chair will be, ah first of all, of course, that chair will set the tone for policy. But then it will come down to how the views of the committee evolve in response to how the economy is behaving.
00:05:55
Speaker
And now let's just be clear. The backdrop is one where there is an unusual amount of political commentary, particularly from the president of the United States, around what the direction of monetary policy should
Fed Independence and Political Pressure
00:06:11
Speaker
be. And so this whole issue about Fed independence and whether or not the Fed's policy and interest rate decisions are affected by political pressures, that has become a talking point in a way that we haven't really seen for for a very long time. Dheeraj, what is the market perception of of the Fed independence story?
00:06:35
Speaker
So there's certainly no shortage of questions that are coming through and headlines that are appearing across media platforms. But if you look at the way the bond market is priced, it's not really showing signs of material concern.
00:06:46
Speaker
And one of the ways we might see Fed credibility concerns really coming into pricing is in the way inflation expectations are being priced. If we look at near-term inflation expectations, for example, in the swap market, they have actually come down across the past one year. And this is something that Chair Powell flagged in his post-meeting press conference. And if we look at longer-dated inflation expectations as well, they've remained very well-behaved and range-bound really across the entirety of these Fed independence narratives over the last six to nine months. And of course, as we get closer to the potential announcement of the new Fed chair, as this new chair, whoever it is, has to make decisions about policy, there could be risks that these expectations might be de-anchored, but for now, they've really remained well-behaved. And what that tells us is that the baseline expectation for the market is really that Fed policy will continue to be driven by the economic data and the dual mandate will remain squarely in focus.
00:07:42
Speaker
And Ryan, has Chair Powell said anything about this issue of Fed independence, for example, at the press conference this week? Well, Chair Powell has just continued to emphasize the importance of Federal Reserve independence. And again, i would put it back to the Fed's dual mandate. You know, it's it's inflation, as I mentioned, is still running a little bit elevated. It's not as high as it was a few years ago.
00:08:08
Speaker
But at the same time, the majority of the FOMC is very committed to making sure that inflation ah doesn't reaccelerate and and you know really eventually returns back to the 2% target.
00:08:20
Speaker
Admittedly, other policymakers are focused, again, as Dheeraj highlighted, on those possible downside risks to the labor market. And so I think that tension will continue. And Chair Powell is just emphasizing, look, it's going to be about the economy and it should be about the economy that drives the future course of policy rates.
00:08:36
Speaker
And can you just remind us the broader composition of the policymakers? It's like you said, it's not just one person.
FOMC Structure Explained
00:08:44
Speaker
It's it's a group 12 voters. voters Yeah, so it's a little bit of a confusing structure. There are 19 overall policymakers. In any given year, there are 12 voters and seven non-voters.
00:08:58
Speaker
And that voting rotation changes a bit. ah But of course, the the chair of the Federal Reserve, as well as the broader board of governors, are permanent voters. And so they're very important in these ah policymaking apparatus.
00:09:13
Speaker
So look, we know we'll wait and see. Hopefully, we'll we'll have more to discuss on that when there is an announcement. Let's just get back to what people should be thinking about when looking at the Fed's playbook for 2026.
00:09:26
Speaker
twenty twenty six Ryan, what are the two data points that everyone should be keeping an eye on? And then, Dheeraj, I'd just like to hear from you. What are the key bond yield levels that that could have an impact Well, the first one I've already mentioned a bit, and that's the unemployment rate.
00:09:41
Speaker
And so the current unemployment rate is just under 4.5%. And the level that I would want our listeners to think about is basically the 5% level. Now, our own forecast is...
00:09:53
Speaker
On our forecast, we don't see the unemployment rate reaching the 5% level this year. But if it were to approach that level, and particularly if it were to surpass that level, I think now you're starting to get into the territory which has historically been associated with economic slowdown, even possible recession. And that's a catalyst that I think could get the Fed to resume rate cuts.
00:10:15
Speaker
The other metric, certainly I would point to would be on the inflation side. And I would mention another level, 2.5% on the downside. On our forecast, we don't see inflation falling below 2.5% this year. We see it sort of staying in this 2.5%, up to slightly above range. A sticky inflation. Sticky inflation outlook. And so Powell mentioned these drivers really as as the two possible catalysts for getting rate cuts to come back into the picture.
00:10:45
Speaker
ah Lower inflation, more confidence that the Fed is getting to 2% on inflation. But then on the more negative side, potential weakness in the labor market, particularly weakness that would take the unemployment rate higher. So 5% and 2.5% are the key numbers to watch. And obviously, there's monthly updates on on those data numbers.
00:11:04
Speaker
Could a government shutdown affect that data like it did last year?
Impact of Government Shutdown on Economy
00:11:09
Speaker
Well, so this is another pressing issue. And of course, it's coming so soon after the record 43-day-long shutdown that started in October of last year. So what I would say is that if there is a government shutdown, again, in a way, it won't be as large in size as what occurred last year because there have been appropriations funded for some federal departments. So...
00:11:36
Speaker
We'll have to wait and see. But at this point, I'm not expecting the same degree of disruption as we saw last year. So fewer government workers not working, basically.
00:11:49
Speaker
That's right. And of course, the other question is that if we do have a shutdown, what will be its duration? Will it end quickly or will it drag on as we saw last year?
00:12:00
Speaker
Dheeraj, what's the key metric to watch in your space?
10-year Treasury Yield Discussion
00:12:04
Speaker
The one metric that everyone in the bond market really focuses on is the 10-year Treasury yield. And if there's really a level of which to watch, it's probably 4%, which is a number that the administration has cited as a level they would like to see the 10-year yield come below.
00:12:20
Speaker
And what we've seen over the last year or so is that the 10-year yield has struggled to really come below that level. And I think it's a reflection of these broader uncertainties, the fiscal concerns, policy volatility that have really resulted in bond investors demanding higher premium to take on risk of holding a security that has a maturity in 10 years from now. And there's a few ways in which we could plausibly see the 10-year approaching that level. It is some ways away from where we're trading today. But of course, one way of getting there is if these labor market concerns do materialize and the Fed consequently delivers more rate cuts than the market's expecting right now.
00:12:59
Speaker
But aside from that, really for the long end to come down, what probably needs to be seen is a greater level of confidence in the overall policy outlook, some more clarity on a number of these big overarching questions, and also probably some progress on the fiscal front, which given the trajectory we've seen over the last few months, the consequences of the One Big Beautiful Bill Act, doesn't look like it's probably going to come through in the next couple of months at least.
00:13:28
Speaker
Well, look, thank you both for for talking me through this. I think we're likely to be talking about this again this year. There's clearly a lot on the table. Stay warm and thank you. Thanks so much.
Extel Survey & HSBC Research Access
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Speaker
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00:14:07
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Podcast Conclusion
00:14:21
Speaker
And if you've got any questions or comments, then you can get in touch with us at askresearch at hsbc.com. So that's all we have time for. This week's podcast was hosted by me, Aline Van Dyne, in New York and produced by Tom Barton in London.
00:14:38
Speaker
Don't forget to like and subscribe the Macro Brief. Thank you very much for listening and we'll be back next week.
00:15:10
Speaker
Thank you for joining us at HSBC Global Viewpoint. We hope you enjoyed the discussion. Make sure you're subscribed to stay up to date with new episodes.