On Thursday, Federal Reserve officials expressed little fear that the recent increase in U.S. Treasury yields may jeopardise a “soft landing” for the economy and suggested that it might even benefit the institution in its fight against inflation.
Last month, the Fed maintained its benchmark overnight interest rate in the 5.25%–5.50% range, but it also made clear that one more quarter-point increase would likely be required before the end of this year to firmly establish the downward trajectory of inflation and that the policy rate would likely end next year above 5%.
Long-term borrowing rates have increased significantly in the weeks following the Sept. 19–20 meeting, a development that Fed policymakers and some analysts think demonstrates that markets are accepting the central bank’s projections for “higher-for-longer” rates.
Early this week, the yield on the standard 10-year Treasury note reached a 16-year high of 4.8%, up from about 4.4% during the last meeting of Fed policymakers.
President of the San Francisco Fed Mary Daly told the Economic Club of New York, “If we continue to see a cooling labour market and inflation heading back to our target, we can hold interest rates steady and let the effects of policy continue to work.”
She continued, “The necessity for us to take additional action is decreased as a result of the increase in long-term rates since financial markets have already made the necessary progress in that direction. There is no need for us to continue.
Higher long-term borrowing costs discourage hiring and investment and slow the economy, easing inflation pressures. The rise in U.S. bond yields, while steep, has not been disorderly, Daly said, adding “so far, so good.”
Chicago Fed President Austan Goolsbee had a similar view, saying that while the timing of the increase in bond yields was sudden, the upward move itself “is not a puzzle.”
Speaking on a Bloomberg podcast that was recorded on Tuesday and aired on Thursday, Goolsbee said, “it’s clear that the long rates coming up is what you’d expect” when recession fears that were prevalent earlier this year have abated.
The Fed’s tightening, which has seen the policy rate increase by 5.25 percentage points since March 2022, has assisted in bringing inflation down from a 40-year high last summer without the associated spike in unemployment.
And unlike what Goolsbee and other Fed policymakers had feared, the banking sector stress that erupted seven months ago with the failure of California’s Silicon Valley Bank did not lead to a credit crisis or throw the economy into a tailspin.
In terms of the actual world, Goolsbee added, he feels that there hasn’t been anything that shows us to be off the “golden path,” in which inflation moves towards the Fed’s 2% target without a recession.
The Fed’s favoured gauge of inflation was 3.5% in August, roughly half its peak from the previous year, while the unemployment rate was 3.8% in August, up from 3.7% in that previous month.
According to Goolsbee, the Fed will act if the increase in long-term yields results in a dramatic slowdown in economic growth or an increase in unemployment.
We definitely keep an eye on that and are considering it, and that might be a blow to the financial or real economies, he added.
Goolsbee stated that for now “all eyes are on getting inflation down.”
Daly emphasised the opposite side with cautions.
“We can react to those data and raise rates further until we are confident that monetary policy is sufficiently restrictive to do the job,” she said. “If the deceleration of growth and inflation stalls, activity begins to reaccelerate, or financial conditions reverse some of this tightening and loosen too much, well, we can react to those data and raise rates further.”