Tomorrow brings the latest Federal Reserve decision, with another quarter-point hike viewed as a slam dunk – current market pricing shows a 93% probability of that outcome. That would bring the Fed Funds rate up to a range of 5-5.25%, which is what their “dot plot” projection from the March meeting indicated would be the likely peak for this cycle. Looking ahead to the following meeting in June, the odds of an additional hike are only 13.5%. In other words, the market is pricing a significant probability that the Fed will be done hiking rates after tomorrow.
There are several factors that make the Fed’s decision-making much more complicated going forward. First of all, progress is being made on inflation with CPI falling from a peak of 9.2% last summer to 5% currently. That’s still not low enough for their liking but is clearly heading in the right direction. Secondly, parts of the economy have been slowing and calls for a recession are growing louder. Third, the lagged impact of their prior tightening over the past 14 months has resulted in four major bank failures in short order, with First Republic being the latest to succumb over the weekend. The extent to which the banking crisis will weigh on future lending activity remains unclear but adds to the economic headwinds.
And last but certainly not least, a major political battle over raising the debt ceiling looms. Yesterday, the Treasury warned that the so-called “X-date” when it officially cannot pay all of the government’s bills may be as early as June 1st, but there are scenarios where it might extend further into the summer. If the debt drama does stretch until June 14th when the Fed next meets, then Chair Powell & Co. may be reluctant to add any additional fuel to that fire with more rate hikes.
From a messaging standpoint, the Fed may still try to avoid uttering the word “pause” tomorrow, but for a number of reasons it sure seems like this rate hiking cycle is finally on its last legs.
Sources: CME Group as of 5/2/23
Carl Noble, CFA®
Senior Vice President of Investments
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