This is the chart that rattled US financial markets on Thursday

It only takes one chart to move the financial markets on Thursday.

That chart was presented by James Bullard, president of the St. Louis Fed, as part of a presentation in Louisville, Kentucky, and shows where he sees “the sufficiently restrictive zone” for the central bank’s main policy interest rate target. Bullard placed the zone somewhere between 5% and 7%, higher than the current Fed Funds rate range of between 3.75% and 4%. That was enough to prompt investors to simultaneously sell stocks and bonds during morning trading in New York, pushing the dollar higher and adjusting expectations about how high interest rates could rise.

Read: Fed’s Bullard says benchmark rate in range of 5%-7% may be needed to lower inflation

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 the other with less generous assumptions. The “Taylor Rule” is a widely accepted equation, or what former Fed Chairman Ben Bernanke described as “a rule of thumb”, developed by Stanford University economist John Taylor for where the central bank’s policy rate should be relative to the state of affairs. the economy.

At present, the current state of the economy includes annual headline consumer price index inflation reaching 7.7% as of October, below 8% for the first time in eight months. While policymakers prefer other indicators of inflation, the annual aggregate CPI rate matters because it can influence household expectations.

Variations on the Taylor rule can produce different results depending on the numbers used, and the upper range of Bullard’s zone is much higher than what traders and investors currently envision. As of Thursday, for example, Fed-Funds futures traders boosted their expectations for a Fed-Funds rate above 5% next year, but did not yet factor in a significant chance of a 6% policy rate.

A team from Goldman Sachs Group GS,
-1.01%
has revised its 2023 expectations slightly upward in a new forecast this week, which says the highest level to which the Fed is likely to raise rates next year is between 5% and 5.25%. However, on Thursday, Bullard described 5% to 5.25% as the minimum level for the benchmark range.

Following Bullard’s presentation Thursday morning, US equities DJIA,
-0.52%

SPX,
-0.98%
fell, led by a 1% drop in the S&P 500 index. The ICE US Dollar Index DXY,
+0.73%
up almost 0.8%. Government bond yields rose, with the exception of 1-3 month rates, pushing the policy-sensitive 2-year rate TMUBMUSD02Y,
4.462%
up to 4.47% and the benchmark 10-year rate TMUBMUSD10Y,
3.778%
up to 3.79%.

The possibility of a 6% fed-funds rate has been around since April, but has not been widely accepted by the financial markets. Softer-than-expected October CPI and producer price data gave investors reason to hope the Fed could moderate aggressive rate hikes, though asset managers and economists said financial markets underestimated the risk that inflation might not fall to 2% fast enough .

Bullard is a voting member of the rate-setting Federal Open Market Committee this year, but will be dropped from the voting list in 2023.

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