After ten consecutive rate hikes over the past 15 months, the Federal Reserve left the fed funds target rate unchanged at 5-5.25%. This was the widely expected outcome following yesterday’s report from CPI, and today’s data from PPI resulted in only 2 to 3 basis points being priced in for a hike, while only 6 of 109 organisations surveyed by Bloomberg expected a hike.
This was a unanimous decision, although several hawks spoke in advance of the need for further rate hikes. However, they clearly expressed their views in the accompanying updated forecasts, which struck a decidedly hawkish tone.
The March dot plot suggests that rates have likely peaked, but the June forecasts show that two more rate hikes are likely before they change course with 100 basis point rate cuts in 2024.
Looking at the individual numbers, nine members expect rate hikes of 50 basis points, two members expect 75 basis points, and one expects 100 basis points. Four members expect a hike, and only two expect rates to hold steady through the end of the year.
To justify this, they have revised their fourth-quarter GDP growth upward to 1% from 0.4% a year ago and lowered their fourth-quarter unemployment rate forecast to 4.1% from 4.5%.
They also revised the core PCE deflator for the fourth quarter upward from 3.6% to 3.9%. Tthe extent of the hawkishness is a surprise. They state that the data will determine what happens next, but given these forecasts, it begs the question: if you do not think policy is tight enough, why not raise rates now?
Chairman Jerome Powell (pictured at today’s press conference), like all other central banks, has repeatedly stated that monetary policy operates with long and varying lags – he did so again at the press conference.
The Bank of Canada, for example, explicitly states on its website that the full effect of a rate hike will not be felt for 18-24 months. That’s the point of an interest rate pause; you give yourself a little more time to assess the impact.
With that in mind, a one-month pause – not a rate hike in June, but one in July – makes little sense. The markets also seem a bit sceptical: On my screen, 17 basis points are now priced in for July, down from 16 before the decision, and 20 basis points for September.
However, it is understandable that the cuts previously priced in are no longer there.
We would interpret this result to mean that the Fed’s dovish behaviour (unanimous pause) and hawkish statements (two rate hikes) provide maximum flexibility to respond to incoming data.
It is keeping monetary conditions tight, but it can get dovish and loosen things up should the data turn out as we expect.
Disinflation trend will accelerate; pause likely to be extended
The market is very encouraged by the composition of yesterday’s report CPI as there were signs of a slowdown in core services excluding shelter costs, which the Fed has been watching very closely.
This area, where there were concerns that a tight labour market would increase inflationary pressures and inflation would be the most persistent, saw a significant slowdown, as shown in the chart below.
With rental prices easing and used car prices falling sharply, we see the possibility of core inflation moderating to near 3% y/y by the end of the year.
As for headline inflation, it had expected June to be 0.2% month-over-month or 3.1%, but today’s numbers from PPI combined with oil price movements mean we could potentially be talking 0% month-over-month or 2.9% year-over-year.
If consumer price inflation hits the 2% mark next month after being over 9% 12 months ago, that would be a huge story, and if we see a slight slowdown on the activity side, it could be difficult for the Fed to justify resuming rate hikes.
Based on a story from ING Bank as a copyright owner
