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The Fed left its policy rate unchanged on Wednesday but surprised economists by forecasting 50 basis points in additional interest-rate hikes this year. That would bring the Fed’s benchmark rate up to a range of 5.5% to 5.75%.
Fed Chairman Jerome Powell said the decision to leave rates steady was a continuation of the process of slowing down policy moves after aggressive hikes last summer and fall.
He stressed that nearly all Fed officials expect it will be appropriate to raise interest rates somewhat further this year.
Read more: Fed skips June interest-rate hike, points to two more increases this year
The Dow Jones Industrial Average
DJIA,
initially plunged on news of two more hikes before recovering as the session continued, while the yield on the 2-year Treasury note
TMUBMUSD02Y,
hit a three-month high.
Here are the key takeaways from Powell’s press conference:
The Fed really didn’t want financial markets to start thinking about rate cuts
When it became clear that the Fed’s leadership wanted to hold rates steady at this meeting, it was always going to be a challenge to avoid signaling to markets that the hiking cycle is over.
Powell’s main goal “was that the markets did not misinterpret them not raising rates at this meeting,” said Richard Moody, chief economist at Regions Financial Corp., in an interview.
To do this, Powell stressed that most Fed officials think more needs to be done and they are not happy with inflation.
Moody said it was a “jawboning exercise”
Josh Shapiro, chief U.S. economist for MFR Inc., said it was the hawkish pause that everyone expected and that the 50-basis-point hike was a “sop to the hawks.”
Doubts swiftly emerge about two more hikes
Many economists said they don’t think two more 25-basis-point hikes are a done deal.
Powell did say that the next Fed meeting in July would be a “live” meeting, which is code for saying that the Fed could very well raise rates that day, said Ian Katz, managing director of Capital Alpha Partners, which analyzes policy for financial firms.
Beyond July it is less clear.
“We think that weaker activity and employment, together with more encouraging signs that core inflation is moderating, will ultimately persuade the Fed that it doesn’t need a final hike in September,” said Paul Ashworth, chief North America economist at Capital Economics.
Ryan Sweet, chief U.S. economist at Oxford Economics, said he was skeptical that the Fed would resume hiking at all.
“Our baseline forecast is for the Fed to remain on hold through the remainder of the year,” Sweet said in a note.
Powell noted that conditions for inflation to fall are coming into place, “which holds open the possibility that progress comes at a faster pace, that maybe we don’t get either one or both of the rate hikes,” Moody said.
No decision on moving at every other meeting
Powell went out of his way not to establish expectations that the Fed would tighten by 25 basis points at every other meeting. He said that pace was not discussed.
Bill Nelson, chief economist at the Bank Policy Institute and a former top Fed staffer, was strongly opposed to a gradual pace. Prior to the meeting, Nelson said establishing market expectations of a gradual pace “is a formula for allowing inflation to become embedded while falling behind the curve.”
Core PCE inflation is the indicator to watch
Powell made clear that the most important indicator going forward will be the core measure of its favorite inflation gauge, the personal consumption expenditure index.
Powell’s new message was, “we really need to see improvement in core PCE in order for them to stop hiking and for them to reach a restrictive level of rates,” said Luke Tilley, chief economist at Wilmington Trust, in an interview.
The May PCE inflation data will be released on Friday, June 28.
Powell downplays stress in banking system from commercial real-estate sector
Powell said that there will be losses to banks from their commercial real-estate loans. But he said that a large part of the lending is in smaller banks and is “well-distributed.”
“To the extent that it’s well-distributed, then the system could take losses,” he said, adding “it feels like something that will be around for some time, as opposed to something that will suddenly hit and work its way into systemic risk.”
Shapiro said any more rate hikes are going to exacerbate problems for banks, which are facing weak balance sheets and fleeing deposits.
He said that is why he takes Powell’s hawkish message “with a grain of salt.”
“They are between a rock and a hard place and are hoping for the best. It is not a great strategy,” Shapiro said.
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