June Fed Meeting: To hike or not to hike?

The 0.25% hike at the last meeting was largely expected to be the final one this year. Opinions have since been divided about the likely outcome of the upcoming meeting on June 13-14. This article examines the reasons for this uncertainty and what they mean for investors.

The economic backdrop

The Fed aims to curb inflation while avoiding recession if possible.

Since interest rate hikes began, headline inflation has declined from a peak of almost 9% in June 2022 to 5%, still more than double the 2% target. The Fed is considering whether to continue fighting inflation or allowing more time for its actions to take effect.

Until as recently as May 23, the consensus was that the Fed would hold rates firm at the next meeting and begin cutting rates before year-end.^[1] With inflation in check, the next issue would be to avoid, or mitigate, a recession induced by the higher cost of capital.

Consumers have already felt the effects of the rate hikes in higher mortgage and credit card rates. Rate increases have also reduced demand for home loan applications.^[2] US consumer sentiment on the economic outlook declined to its lowest in six months in May, although this was partly due to the unresolved debt ceiling negotiations in Congress.^[3]

The banking crisis which claimed a handful of US lenders (including First Republic in early May) appeared to indicate that the Fed may have already gone too far in its rate hikes and quantitative tightening.

Cause for caution

From a broad consensus that it was time to pause, opinions began to change abruptly following the May 26 personal consumption expenditure (PCE) price index data, a measure of inflation favored by the Fed as a broader and more accurate measure of consumer behavior.

PCE increased unexpectedly in April from 4.2% to 4.4% year-on-year, driven partly by energy prices, while core PCE (which was expected to hold steady as it excludes volatile food and energy prices) rose from 4.6% to 4.7%, more than 1% above the prediction of the Fed for end of year.^[4] The data suggested that inflation is not in retreat after all.^[5]

Then came the unexpected news of higher-than-anticipated GDP growth of 1.3% in Q1 (from an estimate of 1.1% in April),^[6] which indicates that rate hikes have had a lower effect on demand, a key driver of inflation.

Finally came the employment figures on June 2, which showed a higher-than-expected increase in new jobs of 339,000, and persistent (yet slowing) wage growth of 4.3%. This contrasts with a rise in unemployment from 3.4% to 3.7%, which implies the labor market might be cooling.^[7] It has been pointed out that employment levels in most industries are above or close to the pre-pandemic status quo, which could support the latter position.^[8]

At the time of publication, the CME FedWatch tool, a snapshot of market sentiment on the upcoming Fed decisions, showed a majority of 74.7% predicting the rate will remain at 5.00-5.25% for the June meeting. However, this is seen as a pause rather than a halt - around 50% of respondents believe the next hike will come in July.^[9]

Conclusion

The past 30 days showed how the most carefully-reasoned predictions can change as the Fed faces inconclusive data trends in balancing its policy between recession and inflation.

Other unpredictable possibilities that may lie ahead include another war, an oil shock, or a string of bank runs.

The Family Office maintains that it is better to stay informed of the situation than invest in the outcome. Riding the temporary dips and allocating capital to the areas of long-term potential requires attention to the signal, not the noise.

Schedule a call with our advisory team to learn more about the longer-term implications for your portfolio.

^[1] Forbes
^[2] CNN
^[3] University of Michigan
^[4] Bureau of Economic Analysis
^[5] Barrons
^[6] CNN
^[7] Bureau of Labor Statistics
^[8] Reuters
^[9] CME FedWatch