13 JUN, 2023
By Constanza Ramos
The Fed’s June meeting will take place between today and tomorrow. International fund managers expect Jerome Powell, chairman of the Federal Reserve, to take a break from raising interest rates. If so, this would be the first meeting since March 2022 at which the Fed does not raise rates. At its last meeting in May, it already hinted at the possibility of an end or a possible pause in tightening. Below, we leave you with the fund managers’ forecasts.
We expect the Fed to pause at its meeting this week. It will be the first time since March 2022 that the institution does not raise interest rates at one of its policy meetings, and the Fed is nearing the end of its hiking cycle.
However, the Fed’s statement is likely to emphasize that no hike is not the same as a pause, as that second case implies a longer period of no policy change. In fact, the Fed’s forecasts are likely to indicate another rate hike this year. We believe the new increase will come in July, but it is also possible that it could be in September if the Fed wants more information on how the economy is digesting the tightening of monetary policy.
The next rate hike will likely be the last in this cycle, as the impact of previous monetary tightening will eventually catch up with the economy and produce a sustained economic slowdown during the second half of this year. The Fed will want to resist any talk of a possible easing cycle for now, but we believe that rates will eventually be cut quite a bit next year, once underlying inflationary pressure subsides.
The Federal Reserve has achieved what it set out to do. It has put policy rates where it said it would and has succeeded in eliminating expectations of a rate cut for the rest of the year. But for policymakers, this does not mean “job done.” We expect the Fed to suspend its rate hike cycle at the June meeting.
Torn between the strength of recent economic data and the long and variable lags between monetary actions and the effect of monetary policy, we expect the Fed to take a “wait and see” approach.
With persistent inflation, mixed economic data and a labor market that remains tight, many expect another rate hike at the July meeting. It is a real possibility. But Jerome Powell needs to buy time. US regional bank stress has subsided, so the macroeconomy is once again the driver of monetary policy. It is in the Fed’s interest to wait and see whether services follow the slowdown in manufacturing, whether the recent rebound in housing is confirmed and, above all, whether the labor market eventually shows signs of fatigue.
However, the tone adopted on Wednesday should be hawkish, to rule out any interpretation that the job is done when core inflation has yet to fall below 5%.
At the May meeting, the Fed hinted strongly that the interest rate hike was over. However, inflation has been firmer than expected in recent weeks, while domestic demand remains quite strong. The banking sector is holding up well, but credit is already tightening, which will have an impact on activity.
At the next meeting, the Fed will have to indicate whether it thinks even tighter rates are needed to curb inflation or whether the contraction in bank credit will replace them. We do not expect a hike on Wednesday, but at least a strong statement, warning that a rate hike could come as early as the July meeting.
The Federal Reserve is right now where it should be. We are in luck, as the central bank has managed to raise interest rates to its desired target and has largely ruled out cuts for the rest of the year without the U.S. economy slumping, at least for the time being. While 2022 was a tough market for both equity investors and fixed-income investors in general, it was necessary to restore rates to a more normal level. And, of course, this is exactly the time when a policy mistake can happen. Continued interest rate hikes risk raising costs throughout the economy and exacerbating an inevitable slowdown, while ignoring any further need to keep raising rates could also allow inflation to persist at higher rates and the economy to overheat rather than slow.
In summary, the market is pricing in around an 80% chance that the Fed will raise rates by 25 basis points in July. This is reasonable and, barring unforeseen upside risks in inflation and the labor market would probably be the last hike. Inflation continues to fall and we expect year-on-year core CPI inflation to be below 4% by the end of the year, with headline inflation also likely to be around 2% to 3%. As for unemployment, it remains near historic lows and, although it is starting to pick up, it is not yet a cause for immediate concern. Furthermore, we do not believe that the recent rate hikes in Canada and Australia are going to spook the Fed, nor do we expect the CPI release just before the Fed meeting to affect the June pause.
We would like to hear a more assertive and convinced Fed chair, with statements less focused on what could happen and more in line with the current situation. In addition, the Fed would do well to remind the market not to get ahead of potential rate cuts. An inconsistent message from the Fed next week risks undoing what it has achieved since it began the rate hike regime in January 2022. If the central bank allows the market to think that rate cuts are just around the corner, it will send the wrong signal to the equity market ahead of an expected U.S. economic slowdown or recession.
Ahead of this week’s Federal Reserve meeting, we foresee a pause in the Fed’s interest rate hike path, as expected by the market. We see the Fed very close to the terminal rate after accumulating a 5% hike in just over a year. With inflation on a downward path and the Fed funds rate still in restrictive territory, the monetary authority led by Jerome Powell may choose to let its policy actions work their way through these “lags”. The latest employment report continues to reflect strong labor market resilience as nonfarm payrolls came in above consensus expectations. However, the increase in the unemployment rate from 3.4% to 3.7% also revealed some softening in the employment data. This is in line with Powell’s desire to control inflation and keep it on a downward path toward his 2% target.
In addition, Fed members have commented that they are keeping a close eye on credit conditions and any potential residual tightening stemming from recent regional banking stress. Fed committee member Daly noted that the pullback in bank lending could amount to “a couple of rate hikes.” Therefore, we believe a hawkish (hard-line) pause is warranted and believe the Fed has the option of “skipping” a hike at a later date as it assesses emerging economic data.
Our baseline scenario remains one of a “soft” landing, characterized by continued disinflation, a weakening labor market, and a manageable slowdown in growth, as widely expected.
By RankiaPro Europe