When the Federal Reserve sits down Wednesday to decide whether to raise interest rates again, it will likely be a game-time decision.
Fed Chair Jerome Powell said that the central bank will make decisions on interest rate moves on a "meeting by meeting" basis.
Last month, the Fed raised its benchmark interest rate to a target range of 5%-5.25%, the highest since 2007.
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Officials will need to decide whether the 10 interest rate hikes so far will be enough in time to cool inflation, or whether more action is needed now. And a key data point — the consumer price index for the month of May — arrives Tuesday as the Federal Open Market Committee begins two days of meetings.
“Inflation is not as low as they want, but heading in right direction," Luke Tilley, chief economist for Wilmington Trust, said in an interview. "CPI is the last possible fly in the ointment that could knock them off a pause."
The Fed will announce its policy decision at 2:00 p.m. ET on Wednesday with Powell set to speak with the media beginning at 2:30 p.m. ET.
Alongside its interest rate decision, the central bank will also release its updated Summary of Economic Projections (SEP), which includes officials' forecasts for the labor market, inflation, economic growth, and interest rates over the coming years.
In March, the SEP suggested the Fed's benchmark interest rate would end 2023 at the same level that prevails today.
Markets are pricing in a 75% chance of a pause at the June meeting based on CME fed funds futures as of 6:45 a.m. ET. The Fed typically doesn’t like to surprise markets.
A Fed divided
While markets appear convinced on what the Fed will do next, the central bank has seemed unusually divided ahead of Wednesday's decision.
“As we move ahead meeting by meeting having come this far, we can afford to look at the data and the evolving outlook and make careful assessments," Powell said on May 19.
In May, Powell also said interest rates may not need to rise as high as previously expected with the bank crisis tightening credit conditions, even with inflation well above the Fed's 2% target.
Coming into the June meeting officials were divided on what to do before the traditional 10-day blackout period began.
Powell has been careful not to tip his hand, along with New York Fed President John Williams, Richmond Fed President Tom Barkin, San Francisco Fed President Mary Daly, Chicago Fed President Austan Goolsbee, and Fed Governor Chris Waller, who have also signaled keeping their options open.
Waller said he was too uncertain about what to do in June, but that he didn’t think the Fed should stop raising interest rates until there is clear evidence inflation is cooling.
St. Louis Fed President James Bullard has said he thinks the Fed should do two more rate hikes, while Dallas Fed President Lorie Logan has said a pause was not in order, though she said that could change depending on incoming data.
Fed Governor Philip Jefferson and Philadelphia Fed President Patrick Harker suggested that the central bank could pause rate hikes at its next policy meeting, though both noted that such a decision wouldn't necessarily mean the Fed was done hiking rates.
Though Harker said he is in the camp of “skipping” not “pausing” at the June meeting, he reserved his final decision based on data he had not yet seen at the time. That includes the May jobs report, which came in stronger than expected, and another read on inflation via the consumer price index scheduled to be released tomorrow.
Data 'would merit a pause'
“Data over the past six weeks would merit a pause,” said Tilley, the chief economist for Wilmington Trust.
The Fed’s preferred measure of inflation — the consumption expenditures index, excluding volatile food and energy prices — rose 4.7% over the prior year in April, accelerating from a 4.6% rise seen in March.
Economists polled by Bloomberg expect inflation as measured by the consumer price index for May to rise 5.2% excluding food and energy prices compared with 5.5% the month before. On a headline basis, prices are expected to have risen 4.1% versus 4.9% in the prior month.
Tilley thinks the Fed has reached the peak on interest rates and that the central bank will begin cutting rates this fall by 50 basis points, as inflation drops and the odds of a recession are pinned at 60%.
Ellen Zentner, chief economist at Morgan Stanley, also expects the Fed to hold the policy rate steady and has likely reached the peak on interest rates.
“We think the data will not meet the bar for a July hike, and the Fed remains on extended hold until the first cut in the first quarter of 2024,” said Zetner. “Banking conditions are stable, but the impact of tighter credit conditions is still uncertain, as are policy lags. We see a very high bar for the Fed to resume hiking post-June and continue to expect it to be on extended hold.”
Wilmer Stith, bond trader for Wilmington Trust, says if the markets are pricing in 80% chance or more for a pause or hike, then that’s a green light for what the Fed will follow. The central bank will only deviate if they have good reason to, he says.
Stith is betting on a pause in June and a hike in July contingent on the CPI data. If the CPI data comes in weaker, Powell and others may offer the impression the Fed could sit back for July, says Stith.
One potential risk: Treasury is set to issue more than $850 billion in new bills between now and September, which could create the potential for higher yields, and thus higher borrowing costs—especially for banks that rely on short-term funding like commercial paper (short-term IOUs issued by companies).
Right now, though Stith says he’s not seeing much evidence.
“The problem is, if in fact, we do see issues, we have been seeing tighter credit conditions and then you lay this on top of that, then that could be of concern, but we still don't know yet,” he said.
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