Reflections on the Fed Meeting

By Hightower Omaha on June 15, 2023

June 15, 2023

The Fed decided to skip the interest-rate hike this time around, leaving the fed funds target rate at 5.00%-5.25%. However, the central bank also disclosed a newly revised Summary of Economic Projections, which included some interesting details. The median projection is now calling for a year-end fed funds rate of 5.6%, which is up from the prior median projection of 5.1%. This means that even though there was no rate increase this time, Fed participants now believe that two additional rate hikes (of 25 basis points each) will be appropriate before the end of the year. In fact, Powell went so far as to say that “nearly all” Fed participants thought that more rate hikes would be necessary to bring inflation back to the 2% target. The chairman also said this: “Not a single person on the committee wrote down a rate cut this year.” These are pretty hawkish comments that appear to contradict the decision to punt this time around. The logical question, then, is that if the large majority of Fed participants believe that conditions will warrant another two rate hikes this year, why skip the rate hike this time? Is the Fed trying to have their cake and eat it too?

My opinion is that the Fed painted itself into a corner. The markets were only pricing in a roughly 6% chance of a rate hike by the time the Fed met this week. These odds had declined over the previous several weeks as some encouraging inflation data came in, while at the same time, various Fed members expressed concerns about the effects of the banking crisis and associated tightening in credit conditions. By “go time,” though, the market reaction to the banking crisis had long since stabilized, signaling there was no systemic problem. In fact, since the recent low on March 13, which was just one trading day after the failure of Signature Bank and two trading days after the failure of Silicon Valley Bank, the S&P 500 is now up about 14% even though bank stocks are roughly flat. Economic data continue to come in better than expected as well, especially with regard to the labor market. And though interest rates have continued to trend higher, credit hasn’t seized up to near the extent many were expecting after the bank failures. So, on balance, financial conditions have not tightened as much as the Fed was perhaps hoping, which could make the job ahead even more difficult. 

The best explanation I heard for the disconnect between the Fed’s inaction at this week’s meeting and their increasingly hawkish rhetoric came from Diane Swonk, who according to The Wall Street Journal said:

“Officials’ projections of penciling in two further increases this year, which was more aggressive than many interest-rate strategists had anticipated, offered a way to unite hawkish Fed officials that would have favored lifting rates this week with those who were more dovish, including Powell, who wanted to wait. This was the ultimate way that Powell corralled the cats, yet again. He clearly is more dovish than some of his colleagues right now, but by all-but-guaranteeing a July rate hike, he was able to keep everyone on the same page.”^[1]

What appears irrefutable at this point is that the Fed believes there is more work to be done. Complicating matters is the recent surge in asset prices and the effect that could have on aggregate demand for goods and services and, therefore, inflation. First, we’ve seen housing prices firm even in the face of a huge increase in mortgage rates. The housing market is usually one of the main transmission mechanisms through which the Fed can impact economic activity. This time around, though, a lack of housing supply is keeping prices elevated relative to where they would otherwise be following 500 basis points of interest-rate hikes. Should the Fed concern itself with the level of housing prices? Maybe not, but we could have avoided a lot of pain if it had done so in the years 2003-2006. 

As for stocks, the Fed likes to feign disinterest in the level of stock prices. But I know it gets nervous seeing such rapid gains coupled with such a heavy concentration in a small number of mega-cap names. Perhaps the investor interest in Artificial Intelligence does not yet rise to the level of “Irrational Exuberance,” but some of the signs of a bubble are becoming apparent. Will the Fed redouble its efforts to rein in the ongoing euphoria? Maybe not, but the sharp recent rise in stock prices could lead to a day of reckoning if inflation does not continue to fall down close to the 2% target. The stakes have clearly risen for investors, and anything short of the mythical “immaculate disinflation,” at this point, could produce disappointment ahead. It’s probably best to avoid chasing the market leaders and forgo some incremental profit while we wait for more clarity on the policy outlook.

Peace,

Michael

[1] https://www.wsj.com/articles/fed-holds-rates-steady-but-expects-more-increases-b1be87f2?mod=Searchresults_pos1&page=1 Wall Street Journal Print edition, June 15, 2023.