The Federal Open Market Committee meeting on 2-3 May is surprisingly shaping up as a relatively quiet affair. Despite the turmoil in markets caused by First Republic Bank, the FOMC and Federal Reserve Chair Jerome Powell may be able to approach the meeting without the usual degree of media maelstrom and market apprehension. Enjoy it while it lasts, especially as unease continues around banking system developments and X date – the point that the US Treasury is unable to fulfil its financial obligations – approaches.
The March FOMC meeting took place against the tumult generated by Silicon Valley Bank’s collapse and worries about an ensuing growth-chilling, deep credit crunch. Markets at the time debated whether the Fed might keep rates unchanged, or hike by 25 basis points and then announce a pause.
What a difference one month makes!
While signs of some US economic slowing abound, especially in manufacturing, activity is holding up – at least for now. Non-farm payrolls and the services purchasing managers index, for example, posted good gains. First-quarter gross domestic product data suggest the American consumer is alive and well. Forecasters continue to delay expectations of when a US recession might commence, now focusing increasingly on year-end – perhaps not propitious timing for President Joe Biden’s re-election campaign – while some continue to argue a soft landing is still achievable.
Fears of large, protracted deposit shifts and financial stress in the wake of SVB’s closure have not materialised. Notwithstanding the latest turmoil surrounding First Republic Bank, the financial situation is much steadier. VIX – the Chicago Board Options Exchange’s volatility index – remains well down over the past month. To be sure, credit conditions are already tightening in reflection of past rate hikes. Analysts fret that community banks will restrict lending more sharply following SVB’s troubles and stresses in commercial real estate. But a significant SVB-induced acceleration in credit tightening is not evident now.
Inflation continues to come down but remains elevated. It is difficult to penetrate the fog given the wealth of inflation data – headline and core inflation, consumer price index versus personal consumption expenditure, trimmed means, non-housing services, employment costs, three-month annualised versus year-over-year. But, on balance, the evidence points to stubbornness in underlying inflation – perhaps for argument’s sake let’s stipulate in the 4% to 5% range – with plenty of hard work still ahead to achieve the 2% inflation target.
In contrast with expectations a month ago, given steadiness in financial markets, persistence in price pressures and continued decent activity, markets are pricing in a roughly 80% or higher probability of a 25bp Fed Funds rate hike to 5.25% at the May FOMC meeting. Fed speakers, prior to the blackout period, were basically in line with and reaffirmed this outlook, and divisions between the FOMC’s hawks and doves were relatively muted.
There will be no dot plot to deal with in May.
Looking towards the mid-June FOMC, markets are predicting the Fed will be on hold. But participants are seemingly more cognisant that credible risks of persistent inflation are weighing on the Fed and that a sustained decline cannot be banked on. While market pricing still forecasts several Fed cuts over the course of the year, analysts are exhibiting less conviction in casting aside the Fed’s last dot plot, which showed no change in the Fed Funds rate over the remainder of the year, once it reaches its peak.
This confluence of factors sets up a less stressful and relatively quieter and lower-key FOMC meeting for Powell. It is unlikely that there will be controversy over the May rate decision. Markets are restrained in debating whether the May hike will be the last increase, though market pricing indicates it should be the peak. Still, the outlook is shrouded in uncertainty. Powell should be able to fall back quite credibly on ‘data dependence’ in response to questions about future Fed actions.
Meanwhile, credit restrictiveness and quantitative tightening will be quietly running in the background, further helping the Fed do its job.
Taking questions from journalists and the public and testifying before Congress can be two highly nerve-wracking experiences for officials, especially when market volatility can be triggered by any word, let alone others’ perceptions of those words. Being in a room of vipers might be a more pleasant experience.
But the FOMC meeting and press conference for Powell may be a relatively quiet affair. June may not be so pleasant, especially as the Treasury approaches its X date.
Mark Sobel is US Chair of OMFIF.
Image source: Federal Reserve