When the Federal Reserve last met at the beginning of May raising rates by 25bps as expected, the market reaction was relatively benign.
There was little in the way of surprises with a change in the statement seeing the removal of the line that signalled more rate hikes were coming, in a welcome sign that the US central bank was close to calling a halt on rate hikes.
Despite this signalling of a possible pause, US 2-year yields are higher now than they were at the time of the last meeting.
This is primarily due to markets repricing the likelihood of rate cuts well into next year due to resilience in the labour market as well as core inflation.
Some of the recent briefings from various Fed officials do suggest that a divergence of views is forming on how to move next, with a slight bias towards signalling a pause tomorrow and looking to July for the next rate hike.
At the time this didn’t appear to be too problematic for the central bank given how far ahead the Federal Reserve is when it comes to its rate hiking cycle.
The jobs market still looks strong, and wages are now trending above headline CPI meaning that there may be some on the FOMC who may be concerned at the message a holding of rates might send, especially given that the RBA and BoC both unexpectedly hiked rates this past few days.
With both Fed chair Jay Powell leaning towards a pause, and potential deputy Chair Philip Jefferson entertaining similar thoughts in comments made just before the blackout period, the Fed has made itself a hostage to expectations, with the ECB set to raise rates later this week, and the Bank of England also set to hike next week.
This presents the Fed with a problem given that it will be very much the outlier if it holds tomorrow. Nonetheless there does appear to be increasing evidence that a pause is exactly what we might get, after today’s CPI report came in at 4%, with the challenge being in how this decision is presented to the markets.
If the message you want to send is that another hike will come in July, why wait when the only extra data of note between now and then is another CPI and payrolls report?
While headline inflation may well be close to falling below 4% the outlook for core prices remains sticky, and at 5% on a quarterly basis, and this will be an additional challenge for the US central bank, when it updates its economic projections, and dot plots.
The Fed currently expects unemployment to rise to a median target of 4.5% by the end of this year. Is that even remotely credible now given we are currently at 3.7%, while its core PCE inflation target is 3.6%, and median GDP is at 0.4%.
As markets look to parse this week’s new projections the key question will be this, is the US economy likely to be in a significantly different place between now and then, and if it isn’t then surely, it’s better to hike now rather than procrastinate for another 5 weeks, especially if you are, as often claimed “data dependant”.