13/06/2023 After ten consecutive interest rate hikes, there is hot
anticipation that the Federal Reserve may finally hit pause with an unchanged decision on
Wednesday. Chair Powell has been emphasising there is now a “meeting by meeting” approach as
he disengages auto pilot and prepares the US economy for what he hopes will be a soft
landing. The market has long anticipated the change of gear, with rate cuts priced into the
market even as the Fed hiked rates, as if investors can’t quite believe that we reached such
heady heights of 5% interest rates and that a descent back towards the zero percent levels
of the past 15 years must be back on the flight path. It’s hard to swallow higher-for-longer
when the dominating theme of the last couple of decades has been lower-for-longer. This
psychology has created a rod for the Fed’s back. With inflation at forty year highs they had
to scramble a quick U-turn from “transitory” to credible inflation fighters. But the market
has never really believed this to be anything other than a short-term phenomenon. Throughout
the rate hikes that have taken place over the past fifteen months, the market has focused on
when this will reverse into rate cuts.
Hence the focus on the word
“pause”. This would validate the market expectation that the peak in rates has been reached
and then it’s just a question of when the cuts begin. But the Fed don’t know if they are
done. Inflation remains far above their target, albeit declining from its near double-digit
peak. The labour market remains tight, with unemployment hitting its
lowest
level in 54
years in February. Wages, where economists look for the fearsome second-round effects of
inflation, remain buoyant. If they ease up now, they run the risk that they failed to apply
the brakes on an overheating economy. They need to buy time to find out. If the market
really does think that they’re done, the yield curve will move to price in more cuts, easing
financial conditions before the inflation demon is slayed. This means that we are hearing
Fed speakers use the word “skip” rather than “pause”. They want to suggest that more hikes
are coming but they need more time to decide when to deploy them.
- Bostic attempted to
describe
it as follows: “I would say it was a pause, but a pause could be a ‘skip,’ or it could be a
hold” - Harper
explained
that “A pause says that you are going to hold there for a while… I am in the camp
increasingly coming into this meeting thinking that we really should skip” - Logan doesn’t even think it’s time to skip,
saying
in
mid-May that “The data in coming weeks could yet show that it is appropriate to skip a
meeting. As of today, though, we aren’t there yet”.
The
Fed Minutes
from the
last meeting
showed
two camps were
developing: “One that was advocated by “some” members judged that progress in reducing
inflation was “unacceptably slow” and would necessitate further hikes. The other, backed by
“several” FOMC members, saw slowing economic growth in which “further policy firming after
this meeting may not be necessary.” Decoding the language, “some” is greater than “several”,
suggesting that the hawks have the upper hand. Waller has been in the more hawkish camp and
he
suggested
at the end
of May that the decision was finely balanced:
- “I do not expect the data coming in over the next couple of months will make it clear
that we have reached the terminal rate. And I do not support stopping rate hikes unless we
get clear evidence that inflation is moving down towards our 2% objective. But whether we
should hike or skip at the June meeting will depend on how the data come in over the next
three weeks.”
Three weeks’ worth of data doesn’t feel like much fresh
information for an economy the size of the US. In any case the data has provided a mixed
picture. We won’t get the latest CPI number until the day before the Fed meeting but core
PCE, the Fed’s preferred measure, has been sticky around 4.7% for the last six months which
is still well over double their target. The latest jobs report showed a strong headline
number but a rise in the unemployment rate as immigration fuels more workers into the jobs
market and workers move out of self-employment back onto payrolls. The report demonstrated
how the labour market is still far from equilibrium which shouldn’t be too surprising given
the once-in-a-century pandemic plus the Technological Revolution having changed our living
and working habits forever. The market still struggles to accept this generational shift.
They grab any crumb of support for their Pavlovian belief in lower-for-longer, pricing in
rate cuts wherever possible. Where the banking system has been roiled by bank run dynamics,
the focus fell onto Powell’s
comments
that
“Developments… are contributing to tighter credit conditions and are likely to weigh on
economic growth, hiring and inflation… So as a result, our policy rate may not need to rise
as much as it would have otherwise to achieve our goals”. The market clung to this as a
validation of rate cuts ahead, rather than shaving basis points off the ultimate terminal
rate. Far less attention was paid to his
comments
that “The
data continues to support the committee’s view that bringing inflation down will take some
time”, effectively pointing out that the economy has validated their hawkishness and that
they should not deviate from the path of bearing down on inflation. This is where the latest
Summary of Economic Projections will be a key signal to the market. A pause or skip won’t
prevent at least some Fed members from projecting more rate hikes ahead. The dots will show
that it’s High-For-Longer and at some stage the market will have to wake up to reality.
Lower for longer is not just a hop, skip and a jump away. 
Helen Thomas
CEO of BlondeMoney
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