With market volatility subsiding, real economic growth resilient, and wages and inflation still elevated, it seems likely the Fed will deliver another 25bps hike this week.
At the March meeting, 17 out of 18 FOMC participants believed the federal funds rate needs to be 25bps higher at the end of 2023 than its current target range of 4.75% to 5.00%. Going into this week’s meeting, the question is whether enough has changed over the last six weeks to convince a sufficient share of voting members to change their mind. Following early March’s regional bank stress, equity and bond market volatility has eased, while investors have gone from pricing in a 21% probability of a 25bps rate increase in May on March 13 to an 85% probability today. Economic data have been mixed, but the picture still broadly shows a resilient U.S. economy. Last week, 1Q GDP growth came in below consensus at a 1.1% annualized rate, with a sharp decline in inventory accumulation, continued contraction in housing and slowing business fixed investment, but strong 3.7% consumption growth.
April’s business surveys continue to show a divergence between weakness in manufacturing and strength in services. Turning to the labor market, March’s jobs report showed job creation slowing but to a still strong 236,000, with ongoing moderation in wage growth for all workers to 4.2% year-over-year. Meanwhile, the Fed’s main inflation target, the headline PCE deflator, retreated to a year-over-year rate of 4.2% in March, down from a peak of 7.0% year-over-year last June. Still, with market volatility subsiding, real economic growth resilient and wages and inflation still elevated, it seems likely the Fed will deliver another 25bps hike this week. The question now is whether this will be the last one, and more importantly, when rate cuts might begin.