May's FOMC meeting expected to deliver the final hike in this cycle
Rates forecast to be lower by end-2023
May FOMC meeting expected to deliver the last hike in this cycle
A further 25bps hike is expected from the FOMC today, but we suggest it will be the last one in this cycle and that US rates will be lower by end-2023 than they are now. The key justifications for today’s rise probably rest with the stronger uptick seen in the core PCE reading for last month, which rose from 4.4% to 4.9%, and the surprising increase in the Q1 Employment Cost Index, both of which will likely have worried the ‘hawks’ on the FOMC that a further tightening in monetary policy is needed to ensure any remaining inflation genies do not escape their bottles. A further hike will take interest rates virtually back to where they were before the 2008 financial markets crash. Of course, there is nothing to suggest that another crash is imminent. But given that we have had three bank failures within the last 8 weeks, clear signs emerging of a normalisation in the labour market and concomitant weakening in wages growth, plus increasing downwards pressure being exerted on CPI from items such as margins recompressing, falling rents and lower commodity prices, it is questionable whether or not a further hike in rates today is actually warranted. But the Fed remains solely focussed on the current inflation and activity data, and until they see clear and sustained evidence that both of these things are moving in a downwards direction, they will keep their foot firmly on the tightening accelerator.
Going forward, however, the picture is changing. As noted above, a number of factors are starting to come together to suggest that inflationary pressures have peaked and that CPI will be materially lower by the end of this year. And on top of these deflationary forces has to be factored in the consequences of the banking crisis. Although the Fed’s quick action to guarantee all deposits in all institutions appears to have prevented contagion beyond Silicon Valley Bank, First Republic Bank and Signature Bank, the consequences of this event will certainly be a tightening in lending criteria and reduced credit availability, and evidence from similar episodes in the past shows that credit shocks are bad news for economic growth.
Before the next FOMC meeting in June we will have two more releases of labour market and inflation data, which we expect to show the macro outlook deteriorating. Certainly the leading indicators being seen are increasingly pointing to slower payrolls growth and lower CPI: the NFIB and other business surveys are suggesting activity is already at recessionary levels, with capital expenditure and hiring plans plummeting; initial jobless claims are rising; and discretionary items of expenditure such as airline fares are trending lower. And it should also be remembered that core monthly CPI peaked some two years ago. But of course, monthly data can always be erratic, meaning it is far from certain that such a worsening picture will appear in the hard data so soon. And in any event, the Fed’s obsession with core PCE services ex-housing leaves policy making very much in a straightjacket, oblivious to what is happening in the real economy.
Thus a further tightening is expected today, but with the language around the decision possibly being softened to emphasise that on-going policy is now largely data-dependent with no further rate hikes guaranteed. A step-down in the hawkish language was already given last month when “..ongoing increases in the target range will be appropriate…” was dropped and replaced with “..some additional policy firming may be appropriate.” With the market already pricing in rate cuts being delivered before the end of this year, it remaining unconvinced by the March dot-plot which suggested otherwise, a further softening in the language today will at a minimum raise expectations that today’s hike will be the last before the Fed pauses – but beyond this, we anticipate expectations will also rise that rates will be lower by end-2023 than they are now.