After holding short-term rates held steady at 5% to 5.25% in June, the Federal Reserve expects to raise rates perhaps twice during its four remaining meetings of 2023, though the markets expect fewer hikes and material rate cuts in 2024.
The Fed’s concern is primarily stubbornly high services inflation, which remains well above the Fed’s 2% target and is bolstered by 6% wage growth. Interest-rate futures give a more dovish forecast, expecting a two-in-three chance of a July hike, but with rates broadly flat after that and then falling as 2024 progresses. Most people, including the Fed, see inflation ultimately easing as shelter costs moderate. But the Fed is not willing to contemplate meaningful rate cuts yet.
Meeting Schedule
The Fed will set rates on July 26, September 20, November 1 and December 13. Of these meetings, the next one in July is relatively important because Fed Chair Jerome Powell has signaled this is a “live meeting” and a hike could be coming.
In fact, Powell offhandedly referred to the June meeting as a “skip” during his press conference implying the July decision might involve a rate hike. It will be interesting to see how the Fed manages expectations, with public statements from officials over the coming weeks. The June meeting to hold rates steady was a consensus decision but it is unclear whether that will hold among policymakers for July.
If the Fed follows the loose implications of the Summary of Economic Projections from the June meeting, then November also could see a hike, though the markets currently doubt that scenario. There’s a lot of economic data to come between now and the start of November.
Updated Projections
However, even if there’s no change in rates, the September and December meetings will be notable as the Fed updates its SEP, giving clues to where it sees rates moving in 2023 and beyond. Currently, the biggest disconnect between the Fed and markets comes next year. For December 2024, almost all Fed policymakers see rates at more than 4% or a lot higher. In contrast, interest rate futures suggest rates will very likely be less than 4%.
Data Dependence
The Fed remains concerned about inflation, since core inflation has been sticky. Headline annual inflation is at 4% as of May 2023. That’s down substantially from a peak of more than 9% from June 2022, but materially above the Fed’s 2% goal.
Beyond the headline numbers, the Fed’s bigger concern is with core CPI, which strips out food and energy costs and has remained in range between 5% and 6% for all of 2023 so far. That’s hardly the disinflation the Fed is looking for. Nowcasts for June CPI from the Cleveland Fed don’t see that changing much, with core inflation estimated at 5.1% year-on-year.
That said, there is a broad expectation among the Fed and many economists that the CPI’s measure of shelter costs should see disinflation shortly. Most industry measures see rents and home prices increasing at a slower rate, if not declining in absolute terms in certain regions. The CPI’s measure of shelter costs includes a lag due to its panel construction methodology that hasn’t picked up much in price declines yet. The Fed suspects that will change. Since shelter carries a large weight in the CPI, falling shelter costs could drive some disinflation.
Services Costs
However, despite clear disinflation in many goods, and the expectation of shelter costs easing from their current 8% annual increase, the Fed still has some concern that services costs are not falling sufficiently to show U.S. inflation really is under control.
Assuming shelter costs do moderate over the coming months, services costs are the final piece the Fed wants to see to be confident inflation is beaten. A major driver of services costs is wage costs. The Atlanta Fed’s Wage Growth Tracker has wage growth decelerating, but still running at a 6% annual rate for May. So, there are encouraging signs but services price inflation isn’t where the Fed wants it to be yet.
Annual Effects
With inflation statistics, the months that are dropped from the 12-month series can matter as much as new data added. In the first half of 2023, a lot of high inflation figures from 2022 were rolled out of the series, helping bring inflation down. Now CPI data anniversaries show more moderate monthly figures, broadly closer to current levels. That may provide less of a tailwind for disinflationary trends and may be, in part, why the Fed currently wants to downplay success in fighting inflation.
Other Wildcards
The second half of 2023 includes a number of events that may alter the Fed’s calculus. Perhaps most important is the jobs market, which so far has been hot and defied expectations of pending weaknesses. But if that changes then the Fed will face more of a trade-off in supporting the jobs market with looser rates or fighting inflation with high rates.
Student Loans And Banks
Student loan repayments are expected to resume in the fall, which may weigh on consumer spending. The major banking crisis may have passed with several bank failures, but bank balance sheets do remain under stress from elevated rates, additional fees to cover recent bank failures and potentially weak demand for commercial real estate in which many banks invest.
OPEC And Markets
With OPEC+ production cuts and the U.S. looking to refill its strategic petroleum reserve, that may bring an end to declining energy prices that have helped disinflation over recent months. The stock market matters too as a general, if volatile, barometer of the U.S. economy. For now, the S&P 500 is up significantly for 2023, in contrast to the Fed’s hawkish moves on rates.
Of course, the Fed does not know how these factors, and many others, will play out. But they could end up informing Fed policy decisions over the remainder of 2023. Markets and the Fed broadly agree that we are close to the top of this interest-rate cycle, though another hike or two may be coming. However, the next debate especially for 2024 is that markets see rate cuts coming far sooner than the Fed expects. It is worth noting that for much of 2023 so far, the Fed’s assessment has won out over the bond markets’ perspective.
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