Barring a large upside surprise in CPI figures due Tuesday, the Fed will likely pause the most aggressive hiking campaign in a generation at June’s policy gathering.
If you’re wondering whether I’m both weary and wary of the “most aggressive in a generation” language, that answer is “Yes.” It’s repetitive and, some might argue, a bit misleading.
The real Fed funds rate, adjusted for core PCE, is barely positive. It’s not unreasonable to suggest that as things stand currently, policy settings simply aren’t tight enough for the Fed to achieve its goals.
Of course, if inflation moderates and the Fed holds near terminal, real Fed funds will be higher, but that’s the thing: Core price growth isn’t really moderating anymore.
People with degrees more impressive than mine will tell you there’s “no evidence that the era of very low natural rates of interest has ended.” But us simple folk, bereft though we are of academic journal citations, possess a commodity that’s in short supply among policymakers — namely, common sense. Pandemics, wars, socioeconomic shifts and supply chain shakeups have consequences.
In any event, the Fed’s hawks made it clear two weeks back they’d prefer a hike at the June FOMC. Since then, though, the likes of Philip Jefferson all but pre-announced a pause.
The market has the meeting at ~30%. Between them, the June and July gatherings are just shy of fully pricing one more increase. There’s now just one cut priced for the balance of the year. Generally speaking, the market is on board with the idea that the Fed can hold rates at ~5% through year-end.
If the Fed were to go ahead with another hike on Wednesday, the median 2023 dot would obviously be marked to market. If the Fed pauses, that dot presents a pretty difficult communications challenge for the Committee. Simply put: It’d be hard to sell a pause (or a “skip”) as “hawkish” without an accompanying upward shift in the median dot for 2023. But if that dot shifts up, markets will immediately price the July meeting as a guaranteed hike.
If the Fed pauses and that dot doesn’t shift up, it’d be a green light for risk assets — a “dovish hold,” which the Committee clearly wants to avoid. In that scenario, any statement language aimed at preserving optionality would be outweighed by the unchanged dot, and Jerome Powell can’t be relied upon to thread any needles in the press conference.
So, there’s a sense in which a hike on Wednesday would actually be easier, or at least more straightforward. The 2023 dot would shift up mechanically, and the Fed could leave it to markets to determine how much a couple of “outlier” dots from the hawks are worth in terms of pricing for the July meeting and beyond. If they pause, then the median dot for this year almost has to shift up unless Powell wants to risk emboldening stocks, which just pushed into an ostensible bull market. The statement language would have to be likewise hawkish in order to be consistent with the dot shift.
It’s also eminently possible that the 2024 dot could shift up given inflation realities, the resilience of the US labor market and an American consumer still consumed with consumerism.
It’s hard to see how the Fed can avoid marking up the GDP estimates for this year, even as staff forecasted a recession at each of the last two meetings. Remember: The March SEP was conceived in the shadow of SVB’s failure. It’s now pretty obvious that various worst-case contagion scenarios in the banking sector aren’t going to materialize, even as the longer run impact on lending is an open question.
Ultimately — and assuming June is indeed a “skip” — I suppose there’s no harm in effectively forcing markets to price July as a done deal via an upward shift in the 2023 dot. There’s an abundance of data between now and next month’s meeting, and if the balance of that data plainly suggests more tightening isn’t a good idea, no one will point to the June SEP and shout “You promised us one more hike!”
Context is important. We’ve now seen the RBA and the Bank of Canada restart their respective hiking campaigns to acknowledge better-than-expected economic outcomes and the risk of entrenched inflation. The US economy has clearly performed well in light of the circumstances and inflation is plainly too high, so there wouldn’t be anything “inconsistent” or “anomalous” about a Fed that pauses then hikes a month later.
Normally I wouldn’t say this, but I think it’s fair to assess that Wednesday’s decision has already been made. It’s almost surely a pause, irrespective of what Tuesday’s US CPI report shows. There’s one caveat: If the CPI figures somehow constituted an unmitigated disaster, the odds would obviously favor an eleventh hour change of plans.
Great and timely summary of the current state of affairs. Many thanks.
I’d like to see a pause, but would prefer that the committee put some power behind it by raising a quarter point, recognizing the risks that may still weaken the economy. It would give the statement more weight. The recovery would not be hurt. And there’s nothing wrong with the committee asserting itself.
I like the extra hike now. Not only for the “weight” but also because it creates a bit of confusion. The bull needs to have its reins pulled, especially with all the new paper flying around.
Thanks Mr. L and MFN. For clarity, the weight I referenced was, of course, the weight of the committee’s judgment. I’m not a Powell fan, but the committee is an important institution and it needs to instill confidence. That’s part of its job.
Markets are chaos in motion, which can be destructive in a very bad way if they’re not governed. Recall 2007-2008.
And the economy is not without risks today. No one seems to be talking about pension funds and mortgage backed securities, but they’re still behind the scenes in the economy and there are still “shadow” risks in the US commercial real estate market.
It’s not 2007 again. But I have difficulty with the nature of the risk in CMBS types of transactions, which can present an element of actual danger to the broader economy.
Based on the “Restrictive?” chart above, I’d say the FOMC needs to push through at least two more quarter-point hikes before year-end if it’s serious about getting inflation moving more quickly toward the 2% target. Not expecting a hike in June, but I wouldn’t be sur[rised to see well-spaced 25bps hikes in July and at the late Oct/early Nov. mtg.
Does the US, as the issuer of the world’s primary reserve currency, have any “moral” obligation to keep rates as low as possible?
Third world countries borrowed in USD when rates were near zero. No way they can now service that debt- possibly leading to chaos and uprisings that could negatively impact international economic stability.
If the Fed can thread the needle and not cause international debt chaos, and still do “ok” with domestic inflation- why not? Everywhere I go, there are lots of people out spending- I have not seen anything on the streets that looks even close to what could be construed as a protest against inflation.
Anecdotal, but job/wage growth might be retreating (at least in certain segments)- I personally know 2 mech engineering 2023 grads who had prior job offers from Silicon Valley startups recently rescinded – reportedly due to problems with corporate finances. They both indicated to me that this is not an isolated situation.
Why pause and then try to convince everyone that you are still really potentially hawkish going into next month? 25 bps now parallels moves by other central banks, runs little risk of breaking anything, and perhaps tempers the recent bull in AI tech. Employment is still strong, and the debt ceiling crisis is behind us. If CPI and/or core were to give them any reasonable excuse I think they should hike.
Interesting piece in Bloomberg today: Fed Backs Away From Wages Focus, Bolstering Case for Rate Pause. Discussing how SOME at the Fed are starting to question whether wages are, indeed, what is driving inflation higher. In my humble opinion, it’s about time.
Potential story in The Onion: Jim Bullard starts to question the validity of his macroeconomic models.
Agreed. What would help is if some politicians of whichever aisle persuasion had the balls to at least raise the possibility of rolling back corporate tax cuts in light of “persistently elevated corporate profit margins that risk becoming unanchored.” Instead, we have Merck suing the government, on Constitutional grounds no less, for having the audacity to even dare trying to negotiate drug prices which will affect the company’s $20 billion flagship drug Keytruda … perhaps as soon as 2028. Existential indeed. May this mark the peak in corporate overreach, which like the stock market, seems to always trend higher.