Review the latest Weekly Headings by CIO Larry Adam.
- The Fed’s June meeting could be a market-moving event
- Growth forecasts decline as rate hike expectations rise
- Market’s view of Fed action may be too aggressive
All eyes are on the Fed! With the May inflation reading now in hand, investors are looking ahead to next week’s Federal Open Market Committee meeting (June 14-15) where Chairman Powell will provide the latest bird’s eye view of the US economy. Investors’ belief in the Fed’s aptitude for raising interest rates without causing a recession has been in flux, so next week’s meeting could potentially be a market moving event. This is especially true given the release of the Fed’s updated economic projections and dot plot in addition to the Chairman’s press conference. The financial markets may want an answer on whether the Fed can engineer a soft landing in the ‘blink of an eye,’ but unfortunately it will take some time to see how quickly interest rate hikes will impact the economy. In the meantime, we’re maintaining our faith in the Fed and sharing our insights of what may come from the June meeting.
- Keeping An Eye On The Fed’s Projections | Much has happened since the Fed last updated its economic projections on March 16—two interest rate hikes, three months of economic data, another earnings season (including CEO forward guidance), and time to grapple with the repercussions of the ongoing Ukraine conflict. Below is our summary of the revisions we expect next week:
- Economic Growth | At the March meeting, the Fed lowered its 2022 GDP forecast from 4.0% to 2.8% and maintained above-trend economic growth projections for both 2023 (+2.2%) and 2024 (2.0%). Given some of the slowing in the ‘goods’ component of the economy, we anticipate further downward revisions, consistent with our 2022 GDP forecast of 2.4%. We assume that the Fed’s forecasts will remain above trend and support our expectation of a soft landing, but any material revisions below trend (e.g., +1.8%) will heighten concerns of an increasing probability of a recession.
- Inflation | Unfortunately, the May Consumer Price Index report did not confirm a peak in inflation, as factors such as energy prices have made an easing of inflationary pressures elusive for now. The Fed’s March estimate suggested that overall inflation would decelerate to 4.3%, 2.7% and 2.3% by year-end 2022, 2023, and 2024, respectively. While their expectations for core inflation may be more stable, these estimates are seemingly out of reach. This could suggest a slightly more aggressive rate hike path, something that would concern the financial markets and complicate the Fed’s ability to achieve a soft landing.
- Unemployment | The Fed’s unemployment target (2022 target: 3.5%) should remain stable as labor market conditions remain healthy. Job creation remains robust, initial jobless claims remain at historically low levels and there continues to be ~two job openings per every person unemployed. Job creation and wage growth remain the bright spot of the economy.
- Federal Funds Rate | As of March, the Fed’s 2022 and 2023 fed funds target was 1.9% and 2.8% respectively. But since then, inflation has remained elevated, with Fed members having a singular focus to tame it. Our forecast is that the 2022 target should be raised to 2.25% to 2.5%, but that the 2023 target should remain the same or be modestly lowered. However, if 2022 and 2023 get revised significantly higher (e.g., north of 3.5%), recessionary fears could increase, sending the market lower.
- Press Conference | Chairman Powell’s articulation of the new forecasts and views of the Fed will be listened to closely at the press conference. Admittedly, to date, the Chairman has been very good ‘threading the needle,’ expressing the need to have less accommodative monetary policy while simultaneously assuaging fears that the economy was headed for a recession. Any other messaging, particularly around much higher interest rates, could unsettle the market. This commentary will serve as a prelude to Chair Powell’s semi-annual testimony to Congress (June 22 & 23) and the Jackson Hole Symposium in August.
- The Fed Will Always View The Economy With A Fresh Pair Of Eyes | While we expect the Fed to raise the fed funds rate 0.5% next week and again in July and September, our projected Fed policy path thereafter remains far more patient than what the market is expecting. Our reasoning? First, the action taken thus far has already impacted the more interest-rate sensitive areas of the economy such as housing. In fact, mortgage applications have declined 33% from the recent peak and buyer traffic has begun to lessen. Second, sentiment has weakened across the board. Consumer, CEO, and investor confidence are all at multi-year, if not record, lows. This is important because to prevent a self-fulfilling prophecy, the Fed will need to boost sentiment sooner rather than later. And third, some of the forces that are expected to drive inflation lower (e.g., rising inventories, discounting, transportation costs, wage pressures) are in place and should lead to a deceleration in pricing pressures. We also remain in the camp that some inflation with healthy job creation is preferred over stifling inflation at the expense of a recession and lay-offs.
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