FOMC “skips” a rate hike and predicts stronger growth
Corporates | Kennett Square, PA
Last Wednesday, the FOMC released its decision to pause rate hikes. This comes after 10 consecutive rate hikes to get to the current target range of 5.00-5.25%. Since the start of this hawkish cycle, the Fed has struggled to put a dent in the will of the American consumer but will now pause in anticipation of any lagging economic effects.
Pause for effect
The statement released by the Fed said that, while the 2% inflation target is at the forefront of their minds and additional rate hikes are still possible, they believe that the economic effects of the rate hikes and the tightening credit conditions in the banking industry are not yet fully realized. While the rate hikes have had major effects in slowing private domestic investment, a pause will give time for any slowdown in personal consumption to materialize in the data that sway the Fed’s decisions. Possibly compounded by the delay in initiating rate hikes, this lag effect in monetary policy is a well-documented mystery among economists and has been mentioned multiple times by Fed Chair Jerome Powell during recent press conferences.
A portion of this lag effect may stem from long-dated agreements where buyers and sellers lock in prices in advance and protect each party from market movements in the short term, like forward contracts. This allows corporations and consumers to operate partially unaffected until renegotiations or contract maturity arrives, and current market conditions come into consideration. This also helps explain why even though high inflation is a large concern, unexpected high inflation is what disrupts an economy as it is not accounted for when setting future prices. The chart below shows that when comparing today’s inflation to prior expectations of today’s inflation, there is a convergence that may indicate that the economy is better suited to operate with high inflation.
Although the rate decision took few people by surprise, markets did react to updated economic predictions from FOMC members. These projections further illustrated their concern and uncertainty over inflation. Members hinted that their battle will likely be slow and drawn out with most of their predictions being revised upward in favor of a bullish market, including real GDP being revised to grow 1.0% in 2023. Core inflation showed once again to be slow to come down, with used vehicles and transportation services leading the charge for May, and the advance estimate for retail sales showed higher-than-expected growth. Chair Powell said he expects rate cuts coming in a few years and noted that, “Not a single person on the committee wrote down a rate cut this year.” This news drove both short-term and long-term rates higher.
Elsewhere in the world, the European Central Bank raised their policy rate another 25 basis points to 3.5% and pointed to more rate hikes in the coming months. The IMF chimed in saying that the rate hikes are not enough. They proposed governments should consider cuts to spending to help curb growth. EU inflation came in at 6.1% YoY in May.
The week ahead
The Bank of England will receive May CPI numbers on Wednesday and is expected to raise rates by 25 basis points on Thursday. Also on Thursday, Chair Powell will testify before the Joint Economic Committee about recent monetary policy actions.
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