Inflation, Labour Market and the FOMC
This aggressive step is just the first of three half point moves anticipated by markets at its next meetings in June and July. Policymakers are focused on the historic pace of inflation at 40-year highs and the associated risks.
Markets have been left in no doubt that the FOMC intends to speed up rate hikes to get the Fed Funds target rate quickly back to neutral. The March FOMC minutes revealed that a 50bp hike could have been on the table had it not been for the Ukraine conflict. That is a rare event when the Fed even considers delivering something that was not pre-discounted by the market (even if often pushed there by the Fed in the first place).
Chair Powell himself has said it was appropriate to “be moving a little more quickly” to tighten policy. indeed, he guided that “theres something to the idea of front-loading” rate hikes. The latest inflation print hit 8.5% and Fed officials have warned of upside risks to price growth due to war in Ukraine and Chinese lockdowns.
The tight labour market should also be confirmed with another healthy non-farm payrolls report on Friday, which should trump the surprise first quarter GDP contraction. Wages are rising amid a lack of workers with most economists seeing US consumer price growth remaining elevated above 4% during 2022.
Fed Funds Rate Forecasts for the Rest of the Year
Markets are betting that the Fed funds rate, currently between 0.25% and 0.5%, will be lifted to 2.7% by the end of December, pushing potentially up to 3% next year. Financial conditions have begun to tighten, in anticipation of quantitative tightening that should be formally announced on Wednesday. We also note that sentiment figures have been edging lower recently. This could point to a cyclical slowdown in the second half of the year.
But monetary policy remains highly accommodative with the US 10-year “real” rate only just turning positive. That means it is still below neutral which signifies that policy remains very easy. Many economists see risks may be skewed towards faster rate moves and an even stronger dollar. A half point rate rise is baked in so it will be down to Chair Powell and a repeat of an “expeditious” normalisation of policy to keep the buck bid. The key question is how fast the Fed can raise rates without slowing growth and causing a US recession.
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