FOMC preview: One and done?

While it’s clear the Fed will raise the fed funds rate target by 25 basis points to a range between 5.25% and 5.50%, there’s less clarity about whether this will end the hiking cycle.

The Federal Open Market Committee meets Tuesday and Wednesday.

In its latest Summary of Economic Projections, most FOMC members saw rates of at least 5.50%, suggesting at least two more hikes this year.

Judith Raneri, vice president and portfolio manager with Gabelli Funds

Even with more tightening, “we may not hit that recession,” said Judith Raneri, vice president and portfolio manager with Gabelli Funds.

The market has priced in a quarter-point hike for this meeting, Blake Gwinn, head of U.S. Rates Strategy, and Izaac Brook, an analyst of U.S. Rates Strategy at RBC Capital Markets, noted. “The Fed, tellingly, made no attempts to push against that market pricing into the blackout period.”

The only change they foresee to the post-meeting statement may “be some slight softening in the language around inflation,” as the FOMC takes a “data dependent approach for the next few meetings.”

No market movement is expected from the meeting, Gwinn and Brook said, with the only possible market mover being Fed Chair Jerome Powell’s press conference, “but we don’t think much will be revealed here.”

It’s too early to project the September move or pause, they said, with a possible hint coming from the Jackson Hole symposium next month.

Still, Morgan Stanley believes in the one-and-done scenario. “Slowing jobs and inflation raise the bar for the Fed to resume hiking post-July, and we continue to expect it to be on extended hold before making the first 25 bp cut in 1Q24.”

Should the Fed acknowledge inflation is softening, or delete the word highly from its statement — the committee remains highly attentive to inflation risks — “it could be taken as a dovish surprise by market participants,” Morgan Stanley said.

“Policy lags and lending conditions should feature prominently at the meeting,” said BNP Senior U.S. Economists Andrew Schneider, Yelena Shulyatyeva and Andrew Husby. “The latest iteration of the Senior Loan Officer Opinion Survey, which we expect to show further tightening, should help inform a growing internal debate on whether previous rate hikes have yet to feed through to the economy.”

While they see a tightening bias remaining in place, with acknowledgment that policy is close to a sufficiently restrictive level and future moves will be data dependent, the July hike will end the cycle, they said.

“Decelerating economic activity, lagged effects of previous rate hikes, tightening lending conditions in the banking sector and greater evidence of disinflation will be more prominent in H2 2023, in our view, and ultimately dilute conviction for further tightening,” they said.

Others believe the Fed will mimic the Summary of Economic Projections and raise again after this meeting.

Judith Raneri, vice president and portfolio manager with Gabelli Funds, said, “We’re looking at another 50 basis points, which will be impacted in yields across the entire yield curve. Not so much in the six-years, but definitely in the two- and three-years since those are the most impactful in Fed policy. However, the three- to six-month will still get cheaper from here.”

Although the Fed started raising rates late, she said, the economy has been resilient. But even with more tightening, she said, “we may not hit that recession.”

“We are likely to see another 50 basis points in rate hikes, probably in the form of two 25-point moves,” said Chris Ainsworth, CEO of New York-based tech wealth management platform Pave Finance, despite the fact he believes “they’ve already raised rates too much.”

“It’s not a function of raising rates – it’s a function of the Fed managing forward-looking inflation expectations,” he said. “They got it wrong a year ago, so they have to be overly aggressive to ensure that forward-looking inflation expectations come back down.”

The Fed is about to make a policy mistake, according to Ryan Swift, U.S. bond strategist at BCA Research. “The more difficult question is whether the Fed will make that mistake this year by continuing to hike into an environment of slowing inflation, or next year by holding the policy rate in restrictive territory for too long. As of now, we lean toward the latter scenario.”

Core inflation should slow enough for the Fed to hold after this month. “Ultimately, we see the Fed’s big policy mistake coming next year when it keeps rates too high for too long, even as standard policy rules start to suggest rate cuts,” Swift said.

The Fed shouldn’t raise rates this month, said Bryce Doty, senior VP and senior portfolio manager at Sit Investment Associates. Inflation is waning and more people are entering the labor force.

“As a result, logistical supply shortages are dissipating along with the inflation those shortages were causing,” he said. “Inflation is crossing the critical level where it will be below the fed funds rate, which is an indication of an even more restrictive Fed policy than simply being higher than a 3% neutral interest rate.”

The bond market, through the “sharply inverted yield curve,” Doty said, is ” shouting to the Fed: ‘We know you are raising rates, but it’s a mistake!'”

Although the Fed held rates at the last meeting, they increased “expectations for growth, inflation and employment” for the rest of the year said Gary Pzegeo, head of fixed income at CIBC Private Wealth U.S.

“They sent a message to markets to expect, first the pause to be short, very short, and second, to prepare for higher peak interest rates than they’d previously communicated,” he said.

Gary Pzegeo, head of fixed income at CIBC Private Wealth U.S.

“They sent a message to markets to expect, first the pause to be short, very short, and second, to prepare for higher peak interest rates than they’d previously communicated,” said Gary Pzegeo, head of fixed income at CIBC Private Wealth U.S.

This hike shouldn’t be the beginning “of another prolonged move higher in short-term rates, and we’re still looking at the tightening cycle as being close to an end,” Pzegeo said. While core inflation is too high for the Fed, “job growth is slowing and we expect wages will eventually follow.”

Additionally, questions about lending remain. “Higher rates are taking a larger bite out of corporate cash flow and weaker valuations in areas like commercial real estate should weigh on credit quality going forward,” he added. “Taken together these constraints could accelerate the slowing of growth in wages and broader inflation measures, and we’d expect the Fed to follow by taking pressure off of the rates market.”

While recession remains his base case, beginning and ending next year, Peter Berezin, chief global strategist at BCA Research, sees three scenarios where a recession can be avoided.

First, if the 3.6% unemployment rate turns out to be full employment. “If that were the case, there would be no need for the Fed to keep GDP growth below potential.”

The second is if full employment is above 4%, “but potential growth accelerates so much, perhaps because of AI, that actual growth does not need to fall significantly to create some slack in the economy,” Berezin said.

The final way would be if full employment is above 4%, but “potential growth does not accelerate, but nonetheless, the Fed is able to calibrate monetary policy well enough to achieve a soft landing.”

While he puts the chance of recession at 75%, it will most likely be mild, with a 20% chance of being moderate-to-severe.

While indicators — an inverted yield curve and the slump in leading economic indicators — suggest a deep recession, they have improved recently, noted Jeff Klingelhofer, Thornburg co-head of investments/managing director.

Should recession be averted, it would be the first time “where these signals have flashed red, and we’ve dodged the recessionary bullet,” he said. The reason would be labor market strength and still-elevated savings as a result of the COVID pandemic.

“This labor market strength has been the thorn in the Fed’s side as it’s supported consumer spending and demand even as prices have risen,” Klingelhofer said. “Despite the rising cost of underlying labor, company revenues have increased in excess of the cost of labor, which means companies have been willing to continue to hire and retain workers. Thus far, higher rates are not immediately transmitting into the economy to destroy demand and bring down prices.”

Eventually, he said, the labor market will weaken and recession will ensue. “We continue to believe this will happen later this year or early 2024. What’s important from an investment perspective is that our expected timing does not align with market behavior. We don’t think the market is appropriately discounting recession in either the consumer or business space, which could lead to market dislocations and opportunities for investors.”


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