This is the chart that rocked US financial markets on Thursday

One chart is all it took to move financial markets on Thursday.

This chart was presented by St. Louis Fed President James Bullard as part of a presentation in Louisville, Ky., and it shows where he sees “the tight enough zone” for the main rate target director of the central bank. Bullard placed the zone between 5% and 7%, up from the current federal funds rate range of between 3.75% and 4%. That was enough to prompt investors to sell stocks and bonds in tandem, push the dollar higher and revise expectations about a possible rise in interest rates.

Lily: Fed’s Bullard says benchmark interest rate in 5%-7% range may be needed to bring inflation down

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Bank of Dallas, Federal Reserve Bank of New York, Bullard calculations


Bullard’s zone was based on estimated policy levels recommended by Taylor-type rules, one with generous assumptions and one with less generous assumptions. The “Taylor rule” is a widely accepted equation, or what former Fed Chairman Ben Bernanke described as “rule of thumb,” developed by Stanford University economist John Taylor to determine where the central bank’s policy rate should be relative to the state of the economy.

At present, the current state of the economy includes an annual headline consumer price index inflation rate of 7.7% in October, falling below 8% for the first times in eight months. Although policymakers favor other indicators of inflation, the headline annual rate of the CPI is important because it can impact household expectations.

Variations of Taylor’s rule can produce different results depending on the numbers used, and the upper range of the Bullard zone is much higher than what traders and investors are currently looking at. Fed funds futures traders, for example, on Thursday raised their expectations for a federal funds rate of more than 5% next year, but have yet to forecast a meaningful chance of a rate. director of 6%.

A Goldman Sachs Group GS team,
+0.29%
revised its expectations for 2023 up slightly in a new forecast this week, indicating that the highest level at which the Fed is likely to raise rates next year is between 5% and 5.25%. On Thursday, however, Bullard described 5% to 5.25% as the minimum level for the federal funds rate.

After Bullard’s presentation on Thursday, US stocks DJIA,
+0.58%

SPX,
+0.38%
ended the New York session with a second straight session of losses. The ICE US Dollar Index DXY,
-0.12%
advanced by 0.3%. And Treasury yields jumped – pushing the policy-sensitive 2-year rate TMUBMUSD02Y,
4.445%
up to 4.45% and the benchmark 10-year rate TMUBMUSD10Y,
3.798%
at 3.77%.

The possibility of a 6% federal funds rate has been around since April, but it has not been widely accepted by financial markets. October’s weaker-than-expected CPI and producer price readings gave investors reason to hope the Fed could ease aggressive rate hikes, though fund managers and economists said that the financial markets underestimated the risk that inflation would not fall quickly to the sufficient 2%.

Bullard is a voting member of the Federal Open Market Committee responsible for setting rates this year, but disappears from the voters list in 2023.

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