Inflation report for May will let the Fed skip, but not stop, rate hikes
Tiana Lowe Doescher
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For the first time since the start of the year, markets have finally understood that the Federal Reserve is not going to pivot into cutting the federal funds rate, but for the first time since it began its fastest rate-tightening campaign in four decades, the Fed is actually going to skip hiking rates. Despite worryingly persistent core inflation and unrelenting tightness in the labor market, Chairman Jerome Powell is likely to announce a pause at the conclusion of the June Federal Open Market Committee meeting.
It is not that the data strongly support skipping an interest rate increase. Although the headline consumer price index came in at 4%, below expectations for May, the Fed’s preferred measure of core personal consumption expenditures inflation actually rose to 4.7% year over year, well past estimates. Worse still, the remaining headline inflation, still at least twice as high as the Fed’s target, consists of the stickiest of price categories.
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“Flexible” price CPI was actually negative in the year ending in May, but both headline and core sticky-price CPI stayed north of 6%, where it has been since August of last year. (Core flexible-price CPI is 1.4%.)
While reduced energy prices over the past year have provided welcome relief to consumers, they haven’t come as a result of rate hikes, and those energy prices have driven the majority of the reduction in headline inflation. It’s safe to assume that we would have gotten some sort of signal or leak if the Fed were to decide against the tactical skip telegraphed by Powell, but the data certainly do not back up such a strategy. If we get a fourth subsequent month of core inflation increasing by 0.4% in a month (nearly 5% on an annual basis), the July FOMC meeting will almost surely result in a rate hike.
That’s why for the first time this year, investors understand that the Fed not only has higher to go, but also that there’s a majority chance that rates don’t go any lower at any point this year than they are right now.