Economists warn that if the Fed really "skips", Powell must clearly "hawk"! Otherwise, the last thing the Fed wants to see will be released...
The Fed's June meeting will be one of the trickiest of its 15-month campaign to curb inflation: Fed Chairman Jerome Powell seems intent on not raising rates, while explaining to the public that the cycle of rate hikes is not over.
Fed watchers say the strategy is both sensible and confusing and risky.
Since March 2022, the Fed has raised its policy rate to a range of 5% to 5.25% at 10 consecutive meetings. Now, Powell and several of his colleagues want a "break" from the June 13-14 meeting to assess the outlook, though their quarterly economic projections may suggest that interest rates and inflation this year will be higher than they expected three months ago.
Former Fed Governor Laurence Meyer said:
"The reason they want to pause the rate hike is risk management: there is a lot of uncertainty, they want to collect more data, but if you think you're going to raise rates once or twice more and you didn't raise rates in June, then the question is: why not?"
One possible answer is that the FOMC is trying to "do it both ways": policymakers want inflation to be lowered to its 2 percent target after more than two years above target, but they also don't want to push interest rates too high lest they overwhelm the economy.
The Fed raised interest rates by more than 5 percentage points in less than a year, one of the fastest rate hikes in the Fed's nearly 110-year history. Fed Governor Jefferson said on May 31 that "skipping a rate hike at an upcoming meeting would allow the committee to see more data and assess the impact before deciding on the extent of further tightening."
So far, the economy has been "resistant" to rapid rate hikes than many officials expected. A Labor Department report on Friday showed employers added 339,000 jobs last month, despite rising unemployment.
The US non-farm payrolls report for May was mixed, with nonfarm payrolls rising sharply but unemployment rising
Despite ongoing price pressures, consumer spending remained stable, and the Atlanta Fed's GDPNow model estimated growth of close to 2 percent in the second quarter.
Meanwhile, disinflationary progress has slowed in recent months, particularly in the services sector. The Fed's preferred measure of food and energy removal showed PCE at 4.7% y/y in April. According to an indicator released by the Dallas Fed, the six-month inflation rate after removing abnormal prices is 4.4%, more than double the Fed's target. Anna Wong, chief U.S. economist, said:
"Their public actions over the past two months suggest that they have recently shifted slightly toward concerns about the downturn rather than inflation concerns." The current inflation data is not worth suspending. ”
Wong added that given that inflation is still far from target and unemployment is near record lows, policymakers could raise interest rates at least twice more to fend off inflationary pressures without undermining economic growth.
U.S. PCE saw its strongest year-on-year growth since January in April
Some Fed officials, including Chicago Fed President Goulsby, noted that given the lagged effect of rate hikes and the possibility of massive bank tightening of credit, suggested policymakers should proceed cautiously and carefully monitor upcoming data.
Despite the overall gritty reading, there are other signals that warn, such as the Leading Economic Index of the Conference Federation, which signals a U.S. recession sometime in the next 12 months. When data is confusing, central bankers tend to "take their time" or not act at all. Jeff Fuhrer, former head of research at the Boston Fed, said:
"If supply issues are further resolved in the coming months as expected, then it makes sense to take a break, a lesson from the future, unless supply disruptions drive prices up, and I don't think inflation is rising because of excessive demand."
Difficult communication
But a pause in rate hikes also poses some risks to the Fed.
For much of the year, officials have signaled to markets that they plan to cut interest rates to restrictive levels and stay there for some time. Their median estimate for March showed that interest rates would reach 5.1% by the end of the year. Markets expect the Fed to cut interest rates later in 2023.
If the Fed chooses to skip a rate hike in June, officials could face greater difficulty restarting rate hikes if necessary. To avoid that outcome, Powell needs to make clear at a post-meeting press conference that more work may be needed to bring down inflation.
Diane Swonk, chief economist at KPMG in Chicago, said: "This will send a hawkish message that the biggest risk is that the market 'cuts' rates before them later this year."
Looser financial conditions could boost economic growth and could boost inflation expectations.
Fed officials are eager to ensure inflation expectations remain stable, and some worry that, as Powell warned a year ago, the public could lose confidence in the Fed's ability to pull inflation back to 2 percent because it stays above its target for too long.
A survey by the Cleveland Fed of companies' views on the Fed's inflation target showed inflation in the second quarter at about 3.1%. Before the pandemic, the figure was 2.2%. Other measures of inflation expectations are also rising. Wong said:
"Inflation expectations are currently volatile and vulnerable to instability, and time is waiting."