Hike Time

Macro Markets

FOMC

We have a very important FOMC today, with all eyes on the Powell conference to get guidance into the future of the hiking cycle. The Fed is expected to raise interest rates at this meeting. Markets are pricing in a hike at the moment. CME FedWatch predicts an 84% chance of the Fed raising the Fed funds rate to 5.25%-5.5% at its meeting, up from 74% last week. The labor market remains tight, with nonfarm payrolls growing. June consumer prices data eased concerns, and Q1 GDP growth of 2% in early July has boosted the chance of an additional quarter-point hike.

Most people expect the Fed to stop hiking after this hike. They had initially signaled two hikes (this being 1 of them), but it’s possible that they might ease those concerns with inflation slowing down. This means the 16-month hiking cycle that began in March 2022 could end in July 2023, with rates rising from near zero levels to a range of 5.25% to 5.5%, the highest since 2001.

According to former Chair Ben Bernanke, the Federal Reserve may decide to end its current credit-tightening effort after this week’s widely anticipated interest rate increase. With inflation cooling down rapidly and more than market expectations, the consensus is emerging that Fed may end the aggressive rate hike spree. US CPI data for June came at 3% below market expectation of 3.1%.

The Fed may throw a surprise. Softer private sector jobs growth and cooler inflation data lower terminal Fed funds rate expectations, but the Fed believes policy tightening is still needed for 2% inflation. This is the biggest concern for the market. The main concerns are that the Fed may hike more, keep rates higher for longer or move dot plots up. Should this happen, we have real recession fears ahead.

The target for inflation is still some distance away, and a rebound in price rise may not be ruled out either. Core inflation numbers are still running hot for the Fed to take a final call on inflation. Fed Chair Jerome Powell and his colleagues have indicated that they aim to raise rates further following a pause in June. In its quarterly Summary of Economic Projections released in June, the FOMC projected two additional rate hikes this year. This means after July, another rate hike could be in the offing in September.

GDP

The first look at GDP in Q2 is expected to show growth of 1.8% Q/Q annualized, cooling a little from the 2.0% rate seen in Q1. Credit Suisse notes that consumer spending growth slowed in Q2 to around 1.1% vs Q1’s 4.2%, likely due to higher borrowing costs. Demand for durable goods also fell slightly, despite inflation pressures easing. The bank also expects net exports to have had a negative impact in Q2. On the other hand, the upside case is supported by business investment likely having had a contribution in the quarter. And while residential investment is expected to have very little contribution, the rate of decline eased, though high mortgage rates continue to be a hindrance.

PCE

The Fed’s preferred gauge of core PCE prices is expected to have risen 0.2% M/M in June, easing a little from the 0.3% increase seen in May. Hopes for cooling inflation have been supported by the June CPI data, which, while differing slightly in methodology, posted a muted rise, adding to the argument that the downtrend in core inflation will accelerate. Used vehicle prices posted a decent decline, as well as widespread falls in the prices of other core goods. And there were also signs that gains in core services ex-housing were slowing. “Although that was largely due to a plunge in airfares, which mainly reflects lower jet fuel prices rather than labour market conditions, it is nevertheless the sector Fed officials are watching most closely as they look for evidence the slowdown in core inflation will continue” – Capital economics