Fed Focus || FOMC June meeting preview: A view from behind the curve

FOMC June meeting preview: A view from behind the curve

*Facing a reacceleration in headline inflation on both a m/m and yr/yr basis in May, driven by broad-based price increases, particularly among services, the Fed will likely use June’s meeting as a springboard to launch into a more aggressive inflation fighting stance. Fed funds futures markets have priced in 280bp+ of further policy tightening this year, and a significant probability of a 75bp rate hike this week.

*We expect the Fed will hike rates by 75bp at this week’s FOMC meeting in response to developments on the inflation front and pressured by market expectations in light of recent media reports. The Fed’s forward guidance had suggested a 50bp rise, but this was changed by the pervasiveness of May’s CPI inflation report and the rise in household measures of long-run inflationary expectations. The subsequent change in the Fed funds futures markets and rise in bond yields contributed to the Fed’s decision to be more aggressive. Given Fed Chair Powell’s mid-May assertion that now is “not a time for tremendously nuanced readings of inflation”, and the likelihood of further robust m/m headline inflation prints in June, we also expect the Fed will opt to lift rates by 75bp in July and 50bp in September. This pace of policy firming would lift the Fed funds target range to 2.75% - 3.00%.

*The press conference with Fed Chair Powell will focus on inflation and the Fed’s pivot to a more aggressive pace of rate hikes. Powell will likely indicate the Fed is prepared to maintain an aggressive pace of rate increases until m/m headline and core inflation moderate on a sustained basis, and will likely also emphasize the Fed will be sensitive to incoming data.

*Following the FOMC meeting, the Fed will release its updated Summary of Economic Projections (SEPs). The Fed understands that these conditional forecasts provide important forward guidance to financial markets and the Fed’s recent track record. It is also aware that FOMC members have dramatically under-estimated the rise in inflation and has been far behind in their estimates of the year-end Fed funds rate consistent with their economic and inflation forecasts. The June SEPs are likely to reflect:

-a significant upward shift in the median FOMC member’s projections of the appropriate Fed funds rate by year-end 2022.

-A downward revision to real GDP growth and further upward revision to projections of the year-end unemployment rate in 2023-24.

These projections would be consistent with FOMC members’ acknowledgement that monetary policy is a blunt instrument and that increases in the unemployment rate are likely as the Fed tries to realign aggregate demand and supply. For context, in March not a single FOMC member projected the unemployment rate would rise above 4.1% by year-end 2023 (Chart 1). In sharp contrast, Fed Governor Waller recently stated “if we can get unemployment to just 4.25%, I would consider that a masterful performance”.

*The high inflation is having a mounting negative impact on real disposable income and economic performance. In order to reduce inflation, the Fed rate increases will slow aggregate demand, squeeze margins, and raise unemployment. Sometime in the future, the hit to the economy and unemployment will test the Fed’s resolve. But that’s in the future. For now, the focus is how much the Fed raises rates and the guidance it provides for upcoming meetings. Stay tuned.

Chart 1. Distribution of FOMC Member Projections for the Unemployment Rate

Source: Federal Reserve Board of Governors

Chart 2. Distribution of FOMC Member Projections for Real GDP Growth

Source: Federal Reserve Board of Governors

Mickey Levy, [email protected]

Mahmoud Abu Ghzalah, [email protected]

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