Today's FOMC meeting set to deliver the final interest rate hike of this cycle
Today will deliver another meeting couched in hawkish overtures. But it will be the last such strong message before the inevitable dovish switch is made.
Today’s FOMC meeting is expected to deliver another 25bps rise in interest rates. Indeed, so well broadcast has today’s decision been that the shock would be if such an outcome was not forthcoming. The key interest for the markets, therefore, is the message that Fed Chair Powell gives on the outlook for monetary policy going forward.
The June dot-plot showed a majority of FOMC members expected two more 25bps hikes to be delivered after the June meeting. This means at least one more hike is expected after today. Given that today's meeting comes just six weeks after the June meet, it is very unlikely that Powell will signal a change in that message: to do so would risk undermining the credibility of the Fed’s signalling while simultaneously raising questions about the strength of conviction FOMC members place in the Fed’s own research and forecasts. Accordingly, despite the softer data seen in June, Powell is almost certain to re-affirm that the June forecasts still stand and that the collective view of the FOMC remains that interest rates are expected to be raised again. The June statement has very much tied his hands.
However, the exit ramp from this policy straitjacket will be an acknowledgement that policy settings going forward are also data dependent. The next FOMC meeting will not be held until September, by which time we will have had two more releases of the CPI, PPI, PCE and labour market statistics, the key policy metrics that are currently determining FOMC policy. Consecutive soft releases across the board and the FOMC will have the justification it needs to keep rates on hold in September rather than tightening again as forecast. Indeed, it is the fact that we have had only one month (June) of softer data that is ensuring policy is tightened again today.
While there are valid arguments for suggesting that US economic activity is set to materially slow going forward, as far as the FOMC is concerned, a snapshot of the May and June inflation and employment numbers is not yet sufficient to justify a pause in policy. The average core CPI print over both months was 0.30%, while the average increase in the non-farm payrolls number was 258k. Both these numbers are probably too strong for the FOMC’s liking and do not provide the definitive evidence it is seeking that inflation is on a sustained path back to its 2% target. Accordingly, Powell will likely reference these numbers when justifying today’s decision, notwithstanding the fact that the June readings are widely considered to be finally pointing to an easing in inflationary pressures. And if Powell finds he needs any further support for today’s hike, then the 0.35% average increase in hourly earnings over the same period – 4.2% on an annualised basis – is clearly incompatible with a 2% inflation target.
So where does this leave us going forward? The market is currently pricing in an approximate 19% chance of rates being raised again in September. This suggests that the current FOMC message is being heavily discounted. However, the outcome of September’s meeting is probably more finely balanced than this. Having got the ‘transitory’ inflation argument so wrong (in fairness, along with most other major central banks), the Fed remains incredibly risk averse and needs to be 100% certain that inflation is converging back to target before contemplating any material loosening in policy, even if the consequence of this is the US economy moving into negative growth territory. Powell and his colleagues will not be taking any chances that they get the battle with inflation wrong twice - and in the same direction - in the same cycle. Accordingly, even if Powell himself privately believes that the full impact of the Fed’s monetary tightening to date is yet to be fully felt, and that he considers the outlook for both inflation and employment to be finally softening, he is unlikely to allude to these things. Instead, today looks set to deliver another meeting couched in hawkish overtures. But it is likely to be the last such strong message the FOMC delivers before the inevitable dovish switch is made.