FOMC Preview for June 14: A Skip Not a Pause
Bottom Line: The FOMC meets on June 14 and a debate will place between leaving rates on hold and a 25bps tightening. While we expect the former, leaving rates in a 5.0% to 5.25% range, an upside shock on May’s core CPI due on June 13 could raise the risk of a tightening. With data on balance still quite strong the Fed is unlikely to signal at this meeting that tightening is done. In fact we expect the dots to suggest one more move this year.
Data, particularly inflation, still looks too strong
At the last FOMC meeting on May 3, language anticipating further tightening was dropped for language stating that further tightening may be appropriate. Since the meeting we have seen strong non-farm payroll gains for both April and May, and gains of 0.4% in both core CPI and core PCE prices for April. The data is not unambiguously strong, with a falling workweek leaving aggregate hours worked looking quite subdued despite the strength in employment, and signs of easing inflation visible in the PPI and recent unit labor cost data, though signals on wages are mixed. The most important feature of the data is however stubbornly high core PCE prices, with the yr/yr pace having been stick in a tight 4.6% to 4.8% range for six straight months.
Until the Fed is comfortable that core inflation is moving back towards target, they will not signal that tightening is done. Some will use the strong inflation data to argue for a tightening at this meeting. However, we feel the majority, at least provided May’s CPI on June 13 does not provide a major upside surprise, will argue that with policy expected to act with a lag it is no longer appropriate to move at each meeting.We believe that the Fed is now likely to move on a quarterly basis until inflation starts to show clear signs of slowing. That would mean data will need to show clear signs of losing momentum soon to prevent a move in Q3, but we do expect that by Q4 the evidence that inflation is moving lower will appear more convincing. Philadelphia Fed President Patrick Harker said on May 31 that holding rates in June should be seen as a skip rather than a pause.
Economic forecasts to be upgraded, which is likely to see dots nudged marginally higher
Stubborn inflation data since the March meeting when the last FOMC Summary of Economic projections was published suggests that June’s forecasts will see the near term inflation trajectory revised higher, particularly on the core rate. We expect an end 2023 pace of 4.2% will be projected, up significantly from 3.6% in March. This will however assume inflation starting to lose momentum in the second half of the year and we do not expect much change to the 2024 or 2025 views, from year end estimates of 2.6% and 2.1% respectively made in March. A March end 2023 unemployment forecast of 4.5% looks too high and we expect a downward revision to 4.0%, while 2023 GDP is likely to be revised up, to 0.9% from 0.4% on a Q4/Q4 basis, with little sign in recent data that a recession is imminent. We may however see 2024 and 2025 GDP growth revised marginally lower, particularly if the dots project further tightening.
We expect the dots will anticipate one further tightening this year, and see the views for 2024 and 2025 nudged up by similar amounts. Lifting the end 2023 median to 5.375% from 5.125% will require three participants to shift their view. Lifting the end 2024 view to 4.375% from 4.25% will require only one participant to shift. We expect a move to 4.625%, which would require a change in view from three. For 2025 we expect a year end median of 3.375%, up from 3.125% in March, which would also require three to change their view.
The statement and the press conference
There is not much in the May FOMC statement that appears to need changing, apart from stating that rates have been left on hold rather than raised if that proves to be the case. May’s language about determining the extent to which additional firming may be appropriate may be left unchanged, though the Fed is likely to make it clear that slowing in inflation is needed to prevent further tightening, though possibly in Chairman Jerome Powell press conference rather than the statement itself. Tighter credit given banking sector concerns is likely to continue to be seen as weighing on the outlook, though risks do not appear to have increased since May. Powell is likely to stress that the Fed is a long way off contemplating easing.
After the last meeting we expected easing to commence in Q2 2024 and the Fed to cut rates by a total of 75bps in 2024. If this year sees a further tightening in Q3 as we now expect, and data slows in the second half of 2023, we could now see easing start slightly earlier, in Q1, though we still expect rates to end 2024 at 4.25%-4.50%, meaning only 25bps of easing in each quarter. If the economy avoids recession and core inflation remains above target, the FOMC will have no need to ease aggressively in 2024.