The Federal Reserve has now held three of its eight scheduled meetings for 2023, raising rates 0.25-percentage-points at each of them. With five meetings remaining for 2023, the Fed views itself as likely to hold rates steady or possibly increase them slightly over the remainder of 2023 since “the process of getting inflation back down to 2 percent has a long way to go” as Chair Jerome Powell said at his May 3 press conference.
The Market’s View
In contrast, markets see a good chance that the Fed starts cutting rates before the end of the year. Specifically interest rate futures implies two to four rate cuts are likely before year-end, with virtually no chance that rates remain at current levels as we enter 2024.
Powell acknowledged that “our future policy actions will depend on how events unfold.” However, the tone of the Fed remains biased towards rate hikes. Specifically Powell noted in his comments that “additional policy firming may be appropriate” and that, “we are prepared to do more if greater monetary policy restraint is warranted.” It is worth noting that that Powell only noted scenarios under which the Fed may raise rates further. He did not discuss the possibility of rate cuts until specifically questioned on the topic.
Recession Risk
That said, Powell noted that the Federal Reserve staff forecast did call for a “mild recession”. If a recession were to occur it’s unclear if the Fed would be able to maintain rates at high levels, though Powell also noted that others at the Fed, including him, have differing forecasts.
For example, Powell stated that the risk of recession currently may be lower than many perceive because of the “extremely tight” U.S. labor market and that could make this economic cycle unusual.
What’s Next?
The next scheduled Fed decision to set rates will come on June 14, interestingly the markets see a good chance that the Fed will raise rates once again at that meeting, though that could be the final hike of this cycle. For that meeting only, markets may be more hawkish than the Fed itself.
Remaining 2023 Meetings
Powell was somewhat less committed to an upcoming hike at the June meeting in today’s comments, though of course there is a lot of economic data to come before the Fed meets again. However, the real divergence between markets and the Fed occurs over the four meetings of 26 July, 20 September, 1 November and 13 December. Here the Fed broadly anticipates holding rates around current levels, or slightly higher, and waiting for inflation to trend lower. The market’s view is that rates move lower over that period maybe in 0.25-percentage-point increments, perhaps capped by a slightly larger cut at December’s meeting.
Ultimately, maybe the divergence between the markets and the Fed comes down to the expected path for inflation. Powell spelled this out explicitly. “We on the committee have a view that inflation is going to come down not so quickly… if that forecast is broadly right…we won’t cut rates.”
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