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The Fed could be very close to achieving one of its main policy goals


If the Federal Reserve’s main policy goal these days is to tighten financial conditions, then it should be pretty close to achieving its goals, according to an Evercore ISI analysis. While the Fed is using its monetary levers directly to try to bring down inflation, officials measure their progress through the impact on a host of other metrics, including bond yields, employment data, stock market and real estate prices and the U.S. dollar. In fact, the Fed recently set up its own measure — the Financial Conditions Impulse on Growth , or FCI-G. While the index only updates at the end of the month, Evervore said it expects the FCI-G to show that conditions have tightened substantially, evidenced by rising Treasury yields, as the central bank has continued its rate-hiking campaign. “The recent surge in bond yields has pushed up mortgage and corporate borrowing rates, contributed to the fall in stock prices, and generated upward pressures on the dollar,” Krishna Guha, head of global policy and central bank strategy at Evercore ISI, wrote in a client note Wednesday. “The Fed will have to consider the tightening in financial conditions when setting rates in coming months, including the decision whether to hike in September.” The 10-year Treasury yield recently neared a 16-year high as investors bet on higher growth and rates at the same time that the government is set to issue more than $1 trillion in fresh debt over the next several months to cover a ballooning federal deficit. When the Fed does update the FCI-G, Evercore estimates that it will show the shift in conditions to exact a 0.76 percentage point drag on GDP growth over the next year. That is likely to be followed by a 0.15 percentage point hit in 2025 and 0.1 point the following year. If those projections are roughly accurate, they could convince Fed officials that they’ve done enough in their campaign to slow the economy and bring down inflation. That at least could mean no additional interest rate hikes are needed , even if cuts aren’t forthcoming. “This unexpected tightening in financial conditions would likely lower the pressure on the Fed to deliver another 25 [basis point] rate hike and in particular argues against signaling such a move in September,” Guha wrote along with Marco Casiraghi, policy and macro strategist at Evercore. “Our base is that the Fed will not raise rates further and developments in financial variables reinforce our call.” Market pricing is largely in line with the call that the Fed halts its hiking cycle after raising rates 11 times since March 2022. Traders are assigning about a 37% chance that central bank hikes once more in November, and then are pricing in a series of cuts through 2024, according to CME Group data . However, there are factors challenging that narrative. Economic data has been stronger than expected lately. The Citi Economic Surprise Index recently hit its highest level in more than two years, indicating that current expectations are too low. Also, the Cleveland Fed’s inflation forecasting model is pointing to a 0.8% rise in the consumer price index for August, a move that would boost the year-over-year figure to 3.8%. That’s well above the central bank’s 2% goal and would be a sharp increase from the 3.2% level in July. The Evercore strategists acknowledge that further upside surprises “could challenge our base case.” However, they think the tightening will end up “raising the bar for an additional rate hike” and “be viewed inside the Fed as plausibly creating a safe context in which to move gradually and carefully on hold over the balance of the year.”

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