What will the Fed do next? Follow the economy, not what Jerome Powell says

The Fed excited investors when it admitted in its policy statement last week that it would consider the effects on the economy of delaying all of its rate hikes before considering what to do next. But Fed Chairman Jerome Powell dashed those hopes when he spoke at a news conference about inflation, which the Fed is still deeply concerned about.

Here’s the thing, though: Investors are focusing too much on what Powell and other Fed members are saying about the economy and not enough on the numbers that show how the economy is actually doing.

It’s the Fed still based on the data, that is, it will establish a policy based on the labor market, inflation, consumer spending and many other factors.

Powell spoke last Wednesday, two days before the latest jobs report showed the US labor market is still relatively healthy. Therefore, these new numbers must be taken into account to determine the calculation of the rate increase.

“The Fed continues to learn and adapt. But it’s very data-driven. They don’t know how much they’re going to have to raise interest rates,” said Mark Hamilton, chief investment officer at Hirtle Callaghan.

Investors (and indeed members of the financial media) have become obsessed with betting on what the Fed will do next.

But problems arise when Wall Street begins to accept that a certain outcome on interest rates has been reached, especially when that consensus develops weeks before a Fed meeting. So much can change and there’s always a flood of new data (and new speeches from Fed policymakers) to digest and analyze.

Numbers… not words

“Not a single day goes by where the market doesn’t overanalyze words from Powell or other Fed members,” said Christopher Smart, chief global strategist at Barings. “But this is a very uncertain world.”

That’s why rate hike expectations are constantly changing, often dramatically. Just watch for Fed funds futures ahead of the central bank’s next meeting on December 14th.

The Fed’s key short-term interest rate is in a range of 3.75% to 4%, following its fourth consecutive three-quarters of a percent rate hike last week.

A month ago, the market predicted that there was almost a 13.5% chance that the fed funds rate would rise from 4% to 4.25% in December. The market had a more than 63% chance rates would rise between 4.25% and 4.5% and a 23.5% chance rates would rise between 4.5% and 4.75%.

But after the Fed’s latest hike (and after Powell’s press conference) it’s almost a 50-50 bet on whether the Fed will raise rates by half a point to 4.25%-4.5% or three-quarters of a point. again 4.5% to 4.75%. The odds of an even lower rate hike are completely out of the question.

Bottom line: numbers matter more than words. Consumer Price Index inflation data for October will be published on Thursday. Look at these data more than Fed speeches and volatile interest rates.

Powell and all his colleagues are looking at the same numbers as everyone else. And fed funds rate futures will continue to change depending on how the latest economic reports look.

“All of us in the markets and the people we cover the markets need to look at the data, and it’s important to consider how policymakers interpret and weight that data,” said Leo Grohowski, chief investment officer at BNY Mellon Wealth Management.

So if the CPI report doesn’t show a significant drop in price pressures, the Fed will likely stick to its mantra that it will take longer rate hikes to finally suppress inflation.

Robert Teeter, managing director of Silvercrest Asset Management, said in a report Monday that the CPI needs to provide “good decisions” about inflation “before the Fed abandons its high-stakes game of chicken.”