The Federal Reserve increased its policy rate for the tenth consecutive time on Wednesday, pushing the federal funds rate to a range between 5% and 5.25%.
The 25 basis-point increase was accompanied by changes in the FOMC statement that imply a possible pause in June.
The 25 basis-point increase was accompanied by changes in the Federal Open Market Committee’s statement that imply a possible pause at the Fed’s next meeting in June with a bias toward more tightening should inflation prove sticky.
The Fed has clearly taken a large step toward a pause. Its statement takes note of tighter credit conditions that will weigh on the economy and also includes a new policy paragraph that now reads “in determining the extent to which additional policy firming may be appropriate to return inflation to 2% over time.”
Now, the challenge for Chairman Jerome Powell and other Fed members will be to convince market participants that a strategic pause should not be equated with rate cuts that neither we nor the Fed thinks will be necessary or desired this year.
In our estimation, the Fed’s new position reflects an assessment by the committee that it needs to ascertain the lagged impact of past hikes on the economy and a rapidly changing risk matrix.
While current policy is focused on restoring price stability, a potential pivot toward a strategic pause with a tightening bias reflects the crosscurrents that the Fed is facing.
We now expect the Fed to pause in its rate hike campaign at its meeting on June 14 because of the proliferation of risks to the outlook and to allow the economy to catch its breath following the 500 basis points of rate hikes since March 2022.
It is by no means a done deal, though. We view the June meeting as a live event, and a rate hike remains an option given elevated wages, a robust jobs market and sticky inflation.
In addition, emerging tensions between the hawks and doves on the committee will almost surely drive the economic narrative over the next six weeks. The diversity of outlooks regarding the economy, inflation and risk will vividly underscore these tensions.
We have reached the point where policy decisions have become that much more difficult and the committee will need to strike a delicate balance as it seeks to achieve price stability and financial stability, all while easing unemployment.
The risk matrix includes not only sticky inflation but also financial instability linked to challenges in local and regional banks as well as a looming debt ceiling crisis, which could erupt right around the next policy meeting. Powell in his remarks was careful to outline the risks linked to the United States not paying its bills on time.
We are not confident that inflation will fall enough to declare this rate hike the final one in the current cycle.
Rather, we would expect if there were other shocks to the supply chain or in energy markets, or if inflation moves higher, that the Fed would resume its rate hikes.
Press conference
Powell kicked off his remarks by noting the soundness of the domestic banking system despite recent problems among local and regional banks.
In addition, he made explicit reference to the central bank’s responsibility for obtaining price stability, which was the first of his many attempts on Wednesday to signal to investors that a potential pause in rate hikes should not be interpreted as the precursor to a rate cut.
Powell also made sure to note that past rate hikes have yet to completely show up in the economy, nor have the headwinds associated with tighter credit conditions. Both of which help justify a pause in June.
Powell was careful to note that a decision on a pause had not been made, which is one reason—along with a robust jobs market, wage growth and sticky inflation—why we believe a rate hike at the June meeting is a live option.
The takeaway
The Federal Reserve increased its policy rate by 25 basis points while laying the groundwork for a pause in its rate increases. It is now appropriate that the Fed create policy space in which it can assess the impact of past rate hikes and engage in risk management around both the banking turmoil and the looming debt-ceiling crisis.
We now expect the Fed to keep its policy rate within a range of 5% to 5.25% contingent upon inflation moving down to a range between 3% and 3.5%, which is consistent with our year-end forecast.
Should that occur, then we think the central bank has reached the policy peak for this cycle. If inflation proves stickier, then the Fed will have to consider resuming rate hikes.
Whatever the case, the policy path from here will only grow more difficult and is fraught with risks to the current business cycle.
