Markets estimate that the U.S. Federal Reserve is on course to hike interest rates by 0.25-percentage-points after its next two-day meeting on July 26. There is more economic data to come before then. However, the Fed’s own economic projections paired with recent comments by Fed Chair Jerome Powell and the implicit forecast of interest rate futures all suggest a July hike is probable.
Specifically, the CME Fedwatch Tool currently sees a three in four chance of higher rates at the July meeting. Powell will deliver congressional testimony this week and may use that opportunity to clarify expectations for the upcoming July meeting.
The Fed’s Inflation Concerns
The Fed’s basic concern is that inflation remains too high. That’s what’s signalling another hike could be coming. The Fed’s target for inflation is 2% and as of the most recent CPI report for May, core inflation is running at an annual rate of 5.3%, with headline inflation slightly lower at 4.0%. Yes, headline inflation has fallen substantially from last summer’s peak, but core inflation hasn’t move down much and interest rates have been elevated for some time now.
The U.S. has seen disinflation in many goods and there’s the expectation that shelter costs should ease over the coming months. However, services prices continue to rise at a fast pace and, correspondingly, wages continue to rise at a relatively fast rate according to current estimates.
The Fed worries that inflation won’t be truly beaten until services costs move down, and they don’t want to ease up on rates until then. The Fed’s strategy to achieve that is to hold rates at high levels for some time. As stated in the Fed’s June decision, “nearly all Committee participants view it as likely that some further rate increases will be appropriate this year to bring inflation down to 2 percent over time.” That statement was also reflected in the Fed’s Summary of Economic Projections, which implied another two hikes in 2023. That said, markets are a little more dovish currently, seeing just one more hike in 2023 as more likely.
The Luxury Of A Strong Jobs Market
Part of the Fed’s ability to keep the focus on inflation stems from the robust U.S. jobs market. The unemployment rate has remained between 3.4% and 3.7% since March 2022. This historically robust jobs market, defying many expectations weakness, has enabled the Fed to focus on fighting inflation without much concern for jeopardizing jobs.
If unemployment did spike materially, then the Fed would have a harder choice to make. It could keep the focus on bringing down inflation, but doing so might risk higher unemployment, which is the other half of the Fed’s mandate. There are some signs that trade-off might be coming. Unemployment did rise slightly in July’s unemployment report for the month of June, and weekly unemployment claims have moved up too, but at this point it is unclear if this should be considered a fundamental move, or just volatility in the data. So far, the jobs market has held up better than many expected.
Data Dependence
Economic data could change the Fed’s plans. The key variables to watch will be unemployment and inflation.
A combination of rising unemployment in the next Employment Situation Report on July 7 and encouraging signs of disinflation in the Consumer Price Index Report on July 12 might be sufficient for the Fed to prolong the pause from the June meeting.
However, the Fed looks at a host of economic data over time, and so with just a few weeks before the July meeting, it seems some abrupt changes in economic data would be needed to prompt the Fed to hold rates steady. For now, the Fed appears on course to hike again in July. Upcoming statements from Fed officials together with economic data releases will help clarify the picture as the meeting draws closer.
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