Evening Brief – 04.12.23

The FOMC Minutes from the March 22-23 meeting showed that the staff expected a ‘mild recession’ later this year, yet all committee members didn’t embrace the hundreds of economists’ concerns and still backed a quarter-point interest rate hike.

We’re likely to see another quarter point hike in May (odds remain unchanged at 70%) despite inflation largely cooling off. Headline CPI rose +0.1% month-over-month and 5% year-over-year versus 5.1% expectations, and down from 6% year-over-year. Core CPI, however, rose 0.4% month-over-month (as expected), pushing the index to 5.6% year-over-year, up from 5.5%.

But there are signals now emerging from some Fed members that they want to take in current economic conditions and assess how much of the heavy lifting the credit tightening is doing for the central bank.

The FOMC doves are voting more in these meetings this year. While many may be willing to take a recession, the additional credit tightening may refrain them from voting for another hike. And that’s where the break is going to be. The May meeting may bring a possible dissent as a dovish wing is developing.

In fact, on that dovish argument, the Minutes noted that “Several participants emphasized the need to retain flexibility and optionality in determining the appropriate stance of monetary policy given the highly uncertain economic outlook.”

In addition, “Some participants observed that downside risks to growth and upside risks to unemployment had increased because of the risk that banking-sector developments could lead to further tightening of credit conditions and weigh on economic activity.”

So, if we’re already headed for recession and it’s going to have an impact on inflation then it speaks volumes for caution and the Fed seems to be ignoring it. Bear in mind that the market is dramatically more dovish than the Fed’s dot-plots.

Moreover, since the last FOMC meeting, economic data has surprised to the downside, especially labor market signals, after three months of upside surprises.

The big question is whether there is real sentiment for that hawkish median dot-plot (sticky inflation) or are Fed members leaning more toward a pause and hold (systemic threats and slowing inflation)?