Hawkish pause, July hike all but guaranteed

The Federal Open Market Committee (FOMC) agreed unanimously to hold the target fed funds rate in the 5.0%-5.25% range at its June meeting. The statement and the Summary of Economic Projections (SEP) made clear that the Fed skipped June but left the door wide open for a July hike.

The key line in the statement that was changed to reflect the commitment to hike in July was:

“In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time.”

The operative word in the line is “of,” which replaced “to which.” The shift marks more of a commitment than an option to raise rates in July.

The SEP underscored the point. Twelve of eighteen participants at the meeting expect two or more additional rate hikes this year; one participant sees rates above 6%; four anticipate only one additional rate hike; only two do not anticipate any additional rate hikes this year.

The forecast for growth was revised higher, unemployment lower and core measures of inflation higher. That underscores the Fed’s concern that underlying inflation is becoming more persistent.

The Fed has joined several central banks in recent weeks that have decided to resume or continue rate hikes to deal with stickier core inflation. That includes the European Central Bank, which is expected to continue rate hikes at its meeting tomorrow, despite the common currency zone slipping into a technical recession in the fourth and first quarters.

Powell was able to pull a rabbit from a hat and once again unify members of the FOMC in their vote. He did that by all but committing to resuming rate hikes in July.

During the press conference, Powell stressed that the risks of “overdoing and under-doing” rate hikes are closer to being in balance. He is more on that side of the aisle on risks than some of his colleagues, who have struck a much more hawkish tone than he has since May.

Why are central banks so fixated on inflation, given the dramatic improvements we are now seeing? Those improvements were mainly on food and energy prices. Other prices, which cover the service sector and a larger percentage of the global economy, have proven stubborn.

The challenge is the more we expect inflation, the more we want to be compensated for it. This is at the same time that companies are growing accustomed to raising prices to preserve profit margins. The result is a sort of “profit-wage” spiral, which has already begun to emerge in the eurozone. That could lead to a more pernicious bout of global inflation or worse - stagflation.