Powell paves way for July Fed hike

July hike is now likely…

In the press conference, Fed Chair Powell cautioned against thinking of the decision as a ‘skip’ and that a July hike would naturally depend on the data flow over the coming weeks. However, he also likened the Fed’s thinking to wanting to continue the recent trend of gradually moderating the pace of rate hikes (which has gone from 75bp, to 50bp, 25bp moves per meeting), which he said ‘makes sense as we get closer to our goal’. He also noted that the bulk of the Committee – as indicated by the updated projections – thinks it is highly likely that further rate rises will be necessary to bring inflation sustainably back to the Fed’s 2% target. Indeed, the projections showed that the median FOMC member now expects rates to be some 50bp higher by end 2023 compared to the March update, with forecasts for 2024 and 2025 also raised (albeit by smaller magnitudes). Core PCE inflation forecasts were also raised, alongside GDP growth for this year. While noting some of the disinflationary progress of recent months, on services Powell said that ‘we only see the earliest signs of disinflation’, and that ‘the key to getting wage inflation down is going to be a looser labour market’. The median FOMC member still expects a rise in the unemployment rate to around 4.5% in 2024, though it lowered its end-2023 unemployment rate forecast to 4.1%, likely on the back of recent unexpected resilience in the labour market.

…unless there is a broad-based near-term weakening in data

Given the Committee’s signalling, we now expect the Fed to hike once again at the July FOMC meeting by 25bp. While we expect the data to weaken over the coming months, we think it would take a broad-based and substantial weakening over the next six weeks to move the Committee from their default position of a July rate hike. Thereafter, our base case assumes the economy will have weakened sufficiently to convince the FOMC it has done enough to return inflation back to target in the medium term, and so we currently view it as unlikely the Fed would raise rates beyond the July meeting. But the risks to inflation continue to be to the upside, and while there are clear signs of weakness in some segments of the economy, the cooling in labour demand continues to be only very gradual. Given this, the risk is tilted towards the Fed following through on today’s updated projections and potentially hiking once more following the expected July move. Our base case continues to be for the Fed to start cutting rates in December, which depends critically on a mild recession unfolding over the coming quarters.