This is the chart that rocked US financial markets on Thursday

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

This chart was presented by Fed President St. Louis, James Bullard, as part of a presentation in Louisville, Ky., showing where he sees “the sufficiently restrictive band” for the central bank’s main rate target. Bullard set the band somewhere between 5% and 7%, from the current Fed-funds rate range of between 3.75% and 4%. That was enough to force investors to sell stocks and bonds in tandem, push the dollar higher and reset expectations around how high interest rates could go.

Reading: Fed’s Bullard says policy rate in 5%-7% range 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’s calculations

Bullard’s zone was based on estimated policy levels recommended by Taylor-style 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 to be relevant to the economy situation.

Right now, the current state of the economy includes annual headline inflation from the consumer price index standing at 7.7% in October, falling below 8% for the first time in eight months. Although policy makers prefer other measures of inflation, the annual nominal CPI is important because it can influence household expectations.

Variations of the Taylor rule can produce different results depending on the numbers used, and the upper range of Bullard’s band is much higher than what traders and investors currently envision. As of Thursday, Fed-funds futures traders, for example, were boosting their expectations for a 5% plus Fed Funds rate next year, but had not yet priced in a 6% policy rate as a significant possibility.

A team at Goldman Sachs Group GS,
-0.67%
revised its expectations for 2023 slightly higher in a new forecast this week, saying 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 Fed-funds rate.

After Bullard’s presentation on Thursday, US stocks DJIA,
-0.02%

SPX,
-0.31%
ended the New York session with a second consecutive session of losses. The ICE US Dollar DXY Index,
+0.38%
advanced 0.3%. And bond yields soared — pushing the policy-sensitive 2-year yield TMUBMUSD02Y,
4.458%
up to 4.45% and the 10-year benchmark TMUBMUSD10Y,
3.771%
to 3.77%.

The possibility of a 6% fed funds rate had been around since April, but had not been widely accepted by financial markets. Softer-than-expected readings in the CPI and producer prices gave investors reason to hope the Fed could moderate aggressive rate hikes, although money managers and economists said financial markets were underestimating the risk that the inflation to fall rapidly to 2%. enough.

Bullard is a voting member of the Federal Open Market Committee to set interest rates this year, but falls off the voting list in 2023.

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