The Fed on Wednesday pressed the pause button on the most aggressive rate-hiking campaign in 40 years.
The decision was expected. Markets had all but priced out the possibility of an increase at the June meeting following what counts these days as a “benign” CPI report and, less importantly, a cooler-than-expected read on producer prices released just hours before the decision.
In truth, Philip Jefferson all but pre-announced the Fed’s intention to skip this month’s meeting during a speech on financial stability late last month. “A decision to hold our policy rate constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for this cycle,” the Vice Chair-in-waiting said, on May 31. “Indeed, skipping a rate hike at a coming meeting would allow the Committee to see more data before making decisions about the extent of additional policy firming.” Yes, “indeed.”
Everyone can recite a boilerplate, paint-by-numbers case for the Fed’s decision. Monetary policy acts with “long and variable lags,” the banking sector stress is still likely to constrain credit to the real economy (thereby standing in for some additional Fed tightening), there’s evidence that inflation is slowing and that wage growth is moderating to levels consistent with price stability. And on and on. Throw in pervasive macro ambiguity and you have a plausible case for adopting a “wait and see” stance with terminal at least in sight.
I should emphasize that were you to travel back in time to summer 2021 and show Fed officials the figure above, they’d gasp. “Oh my God. What happened?!” they’d exclaim.
While acknowledging the merits of a forward-looking approach to policy (it was, after all, the Fed’s penchant for fighting the last war which put them behind the curve on inflation in the first place), critics can argue that Wednesday’s decision made little sense. The Fed’s mandate is price stability and maximum sustainable employment. Core CPI inflation in the US is loitering above 5%, PCE price growth is more than double target and the unemployment rate is still near multi-decade lows even after jumping the most since April of 2020 last month. One part of the mandate is clearly met, the other clearly not. If you didn’t know any better, you’d be inclined to call that evidence in support of additional rate hikes, and judging by the new dots, officials don’t believe terminal has been reached.
Updates to the forward guidance were limited to a brief explanation of the pause. “Holding the target range steady at this meeting allows the Committee to assess additional information and its implications for monetary policy,” the statement said, essentially echoing Jefferson. The rest was verbatim from May. To wit:
In determining the extent of additional policy firming that may be appropriate to return inflation to 2% over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals.
Frankly, the statement was neutral. There were virtually no changes. Economic activity has “continued to expand” at a modest pace, job gains are robust and inflation is elevated. All of that was (almost) word for word from the May statement.
The Committee wants to preserve its optionality to restart rate hikes if necessary. There are three key components to that effort. The first is the statement language, the second is the dot plot and the third Jerome Powell’s press conference. The Fed let the dots do the heavy lifting on Wednesday, as I suggested they would.
The median dots all shifted higher (except for the long run marker, of course), and swaps priced out 2023 cuts. As a reminder, this year’s dot had to move up if the FOMC wanted to avoid conveying a “dovish pause” to markets, which I’ve variously suggested would be perilous given clear signs of froth on Wall Street and the read-through of rekindled animal spirits for the wealth effect and thereby spending and inflation.
The Committee was apparently cognizant that the bar for a so-called “hawkish skip” was high. They tried to clear it. The new dots suggest half of meeting participants expect two additional 25bps increases this year. Three officials penciled in even more. (Forgive me, but I told you so. I really did.)
The SEP was hawkish too. The GDP forecast for this year more than doubled to 1% from 0.4% in March, the unemployment rate projection fell to 4.1% from 4.5% and the core PCE projection for year-end was marked higher to 3.9% from 3.6%.
Again: These are hawkish shifts to acknowledge the hot economy, resilient labor market and stubborn core price growth.
All in all, the Fed leaned on the SEP to convey what I can only describe as an overt inclination to resume rate hikes barring additional, convincing evidence that the labor market is loosening and/or that inflation is on a sustainable path back to target.
Of course, this could be a bluff aimed at cooling equity market gains and disabusing (once and for all) rates traders of the idea that cuts are coming in the back half of the year. Whatever the case, it’s consistent with the message from the RBA and the Bank of Canada, which both demonstrated last week that a “pause” can be just that — a pause.
Fed is pausing with FF rate 5.00-5.25% not even caught up to core PCE inflation 5.30%, median dot plot has FF +50bp tp 5.60% by year-end but core PCE -140bp to 3.90% by then, even though Fed has seen little progress on core inflation that it wants to see inflation moving down “decisively”. Fed doesn’t know how long/variable the lags are, sees labor market “extraordinary resilience” driving services non-housing inflation, housing disinflation slower than expected. Hence the repeated question why then are you pausing or in one case why not rip off the bandaid. Answer was to see more data, even though won’t be all that much data between now and July meeting. In the intraday, equities didn’t seem to much care while the bonds took 6 mo up a whopping +1 bp. The 800 lb gorilla seems much diminished these days. No fear of the Fed.
It seems like the Fed’s trying to let banks and other slow moving institutions settle with the idea that “there will be high rates for awhile”… while trying to scare the FOMO rally into behaving (trust me AI hasn’t made anybody hyper efficient yet – in fact Bing and OpenAI are just burning cash and gpu so they can laugh at Google finally losing).