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With the Federal Reserve widely expected to keep its key rate unchanged at 5.0%-5.25% on Wednesday after 10 straight hikes, investors will focus on the central bankers’ statement for any inkling of guidance for its intentions at the July meeting.
At the last meeting, the Federal Open Market Committee kept the door open for a rate increase at future meetings when it said “additional policy firming may be appropriate to return inflation to 2 percent over time.” Any changes to that wording will let markets know which way the Fed may be leaning — toward another “skip” to assess data or toward resuming a path of tightening.
If the FOMC does keep rates unchanged on Wednesday, look to see if any members voted to raise rates this month. That could give investors insight into the debate that occurred at the meeting.
Tuesday’s CPI data supports the Fed skip in June, setting it up as a one-meeting skip, “slowing down to a pace of one hike every other meeting rather than an extended pause,” said Evercore ISI’s Krishna Guha in a note to clients. Furthermore, “the Fed will message a default to go again in July if the tone of the data remains unchanged but no hard lock on July.”
Mary Anderson, investment strategy analyst at Wells Fargo Investment Institute, tells investors to watch the real federal funds rate — that’s the Fed’s policy rate minus inflation as measured by the CPI. At the end of April, the real federal funds rate was still negative at -0.71%, she said.
Recently, the probability for a 25-basis-point rate hike stands at 61.2%, up from 59.9% on Tuesday, according to the CME FedWatch tool.
Looking back at past cycles, the real federal funds rate turned positive before recessions. “We believe the Federal Reserve may have to continue raising rates to quell inflation, and that increases the risk of a recession,” Anderson said, noting that in the past 11 rate-hike cycles, the U.S. economy has only avoided recession three times.
Brian Coulton, chief economist at Fitch Ratings, isn’t so sure that the Fed will be encouraged by the CPI report. Underlying inflation pressures “are still stubbornly high.” While the “super-core” CPI measure, comprised of services excluding rents, fell to 4.2% Y/Y (from 5.1%), rising core goods prices and persistent rental increases “won’t be particularly assuring for the Fed,” he said.
But some see no rate hikes ahead. The CPI showed that “inflation calmed down in May,” said National Association of Realtors’ chief economist, Lawrence Yun. Furthermore, “low inflation means that the Federal Reserve should stop raising interest rates and possibly slash rates towards the year-end or early next year.”
The Fed policymakers will also provide their expectations for where they see rates going over the next couple of years in the Summary of Economic Projections, which will be released at the same time as their rate decision.
In March, the central bankers’ median projection was 5.1% at the end of 2023, unchanged from the December 2022 meeting. The median projection for 2024 year-end was 4.3%, up from 4.1% in the prior dot plot.
22V Research’s Gerard MacDonnell expects the median interest rate dot for the end of the year will rise by 25 bps, with no chance of a 50-bp increase. “The Fed can easily go another 50 this year, but there is no need to signal that now,” he said in a note to clients.
Evercore’s Guha expects the Fed members to be evenly split among three options on the dot pot — those who expect no more hikes, one more hike, or two more hikes by the end of the year.
Last time, the FOMC surprised Fed watchers by raising their projections for inflation. The median core PCE inflation rate for 2023 rose to 3.6% from 3.5% and for 2024 to 2.6% from 2.5%.
SA Investing Group Leader James A. Kostohryz said the CPI print “very much supports a Fed ‘skip’ for the June meeting and increases the probability of another skip in July.” With that, pressure on fixed income markets have eased, marginally increasing the chances of a “soft landing,” he added.
