No Hikes on the Table, But… — Evening Brief – 05.29.24
The monetary policy outlook has been ambiguous, particularly over the timing of the first interest rate cut. However, this is beginning to change as Fed funds futures reflect the chance of an interest rate hike. To be clear, the indicated probability of a hike is exceedingly low: less than 1%. However, the fact that market sentiment is pricing in any possibility of a rate hike indicates a shift.
It’s debatable whether this shift is meaningful. Most Fed policymakers have conveyed in recent months that interest rate hikes are largely off the table, while keeping tight-lipped regarding the timing of rate cuts.
Fed funds futures continue to support that picture, with priced-in probabilities strongly tilted toward no change or interest rate cuts at the next several FOMC meetings. Confidence is high that the Fed will leave the fed funds rate unchanged in June. For September, however, the odds still remain a toss-up, according to CME FedWatch tool.
The U.S. 2-year yield, which is currently trading around 4.90%, has been expecting an interest rate cut for almost a year now.
Recent economic data, however, suggests that the economy is resilient, suggesting it may be premature to rule out a rate hike. Notably, PMI survey figures for May showed that the U.S. economy recovered substantially from April’s contraction. Meanwhile, jobless claims remain low, implying that the labor market may continue to grow at a strong rate.
The inflation rate is the most important variable. The latest numbers show renewed signs of advancement towards disinflation, but the latest Fed minutes remind us that, while rate hikes are still a very low probability, policymakers are considering the possibility, or so it appears if you read between the lines in the latest review of the May 30-April 1 FOMC meeting.
Last month, Federal Reserve Governor Michelle Bowman said it’s possible interest rates may have to move higher to control inflation, rather than the cuts her fellow officials have indicated are likely and that the market is expecting.
“While it is not my baseline outlook, I continue to see the risk that at a future meeting we may need to increase the policy rate further should progress on inflation stall or even reverse,” she said in prepared remarks.
“Reducing our policy rate too soon or too quickly could result in a rebound in inflation, requiring further future policy rate increases to return inflation to 2% over the longer run.”
The idea of a rate hike is subtle via the minutes and most of the Fed commentary overall still skews heavily toward standing pat at most – echoing Fed funds futures. The fact that some Fed officials and futures, however, are starting to explore the possibility for more policy tightening adds a new risk factor to the overall outlook.