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This week’s FOMC decision to take a break from raising the benchmark lending rate was fully expected. What wasn’t expected was the very hawkish outlook going forward. The updated forward guidance, laid out in the quarterly Summary of Economic Projections, gave a picture of a committee even more fully committed to higher interest rates than before. Half of the voting members anticipate the need for two additional rate increases of 25 basis points this year. On top of that, two members envision three hikes, while one member believes it will take four hikes, for a total of 100 basis points, to achieve 2% inflation. If you are counting, that puts the ultimate funds rate at 6%. Of the remaining members, two are content to keep the rate at the current level, while four believe only one quarter point move is necessary.
Federal Reserve Chair Jerome Powell was quick to tell the financial markets not to view the absence of a rate increase in June as a “skip” but rather a “pause.” The pause, the first one in 15 months, provides the Fed time to assess additional incoming data to judge the lagging impact 500 basis points of tightening has had and will continue to have on the economy. Powell said the decision to not raise rates this month “is a continuation of the process” to bring down inflation, which has a long way to go.
The committee updated its projections for key economic metrics based on how the economy has handled higher interest rates so far. The Fed acknowledged the past year of interest rate hikes is not impacting the labor market as the committee had hoped, leading members to reduce the forecast for unemployment from 4.5% to 4.1% by the end of the year. Core inflation is expected to be at 3.9% rather than 3.6% as the pace of falling inflation is moderating. The resiliency of the consumer and the labor market is creating a stronger economy, prompting the end of the year GDP to be 1.0% versus 0.4%.
Key Indicators this Week
Inflation – The consumer (CPI) and producer (PPI) inflation indices for June were a continuation of the pattern seen in recent months. Inflation is moving in the right direction, but at a slow pace. Year-over-year core consumer inflation fell to 5.3%, the lowest level since the end of 2021. Headline CPI measured 4% from a year ago, down more than five points from its peak and the lowest level in more than two years. Some trouble spots continue to keep inflation sticky, namely used car prices and shelter, both of which are expected to fall in coming months. On the positive side, energy and gasoline prices fell substantially. PPI, although not viewed as widely, offers some optimism for falling consumer prices. Both the headline and core year-over-year rates fell to the lowest levels since the beginning of 2021 and are more than seven points below peak rates. The drop in prices came mainly from lower goods prices helped by improving supply chain issues and falling commodity prices. The question now is how much of the reduced costs retailers and consumer-facing businesses are willing to pass on to consumers. Until that happens, CPI will remain well above the Fed’s 2% target and will keep the Fed resolute in raising interest rates, potentially one or two more times this year.
Sarina Freedland – Senior Investment Officer
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