- The Federal Reserve is likely to pause its interest rate hikes at its Wednesday meeting amid a lingering banking crisis.
- This decision comes after the Fed raised interest rates 10 times in the last 15 months.
All eyes are on the Federal Reserve's Wednesday meeting, where it will announce whether it's going ahead with another rate hike or putting its fight against inflation on pause.
Markets think the Fed is likely to skip its interest rate hike at its Wednesday meeting, with Fed fund futures as of Tuesday morning revealing a 94% chance policymakers hold steady.
In just 15 months, the central bank raised interest rates 10 times, though inflation still remains above the 2% target, reaching its highest point in four decades last year. In May, the Fed's Federal Open Market Committee increased its benchmark rate by 0.25 percentage points, pushing the federal funds rate to a target range of 5%-5.25%. This was the first time this rate surpassed 5% since 2007.
Even if the Fed forgoes a rate increase on Wednesday, Fed officials have suggested the Fed may hike rates again at later meetings. Futures traders anticipate a 61% chance of another rate hike in July as of Tuesday morning. Many are split over whether the economy is slowing down enough, and if raising rates too much could lead to a sudden reversal if the banking crisis worsens.
Consumers may need to continue navigating higher costs given the better-than-expected job market and strong inflation, as the Fed's more cautious approach could avoid a recession but slow the economy more gradually. The US labor market added 339,000 nonfarm payrolls in May, according to a Bureau of Labor Statistics report, coming in far above the forecast of 180,000. The US unemployment rate increased to 3.7% in May, higher than the 3.5% expected.
On Tuesday, a Bureau of Labor Statistics report said the Consumer Price Index (CPI) increased 4% from May 2022 to May 2023. This comes in at below the 4.1% forecast and well under the year-over-year percent increase of 4.9% in April. BLS noted it's also the lowest year-over-year rate since March 2021.
The likely pause in June could give officials more time to calculate whether the slowing is part of a more consistent downtrend. Slowing inflation could be due in part to improving supply chains, for instance.
Swelling corporate profits are also in part to blame for inflation, with prices rising despite easing cost pressures from the war in Ukraine and the supply-chain crisis. Average hourly earnings grew by just 0.3% in May, according to the Bureau of Labor Statistics, and have risen just 4.3% over the past year. Wages and salaries in the Employment Cost Index, which measures employee compensation, have seen growth taper off for about a year. Meanwhile, corporate profits reached an all-time high in second quarter 2022, while corporate pretax profits recorded highs in fourth quarter 2022.
In sectors such as housing, which have been heavily impacted by rising interest rates, prices haven't dropped significantly. Though mortgage rates are higher, a housing shortage and low pandemic-era lock-in rates have kept prices relatively high. Shelter prices increased 0.6% in May, up from 0.4% for April 2023, according to the CPI.
Tightening credit conditions this year following the failures of banks such as Silicon Valley Bank and First Republic Bank also point to why the Fed may skip this month's rate hike amid a lending pullback — especially since strong job growth and inflation may have otherwise led Fed officials to increase rates. The credit crunch, which demands looser monetary policy to avoid putting too much stress on smaller banks and keep the economy from falling into a recession, clashes with tightening policy to fight higher inflation. Fed Chair Jerome Powell remains at a crossroads between focusing more on battling inflation or on bank regulation.
A New York Federal Reserve survey released Monday further found consumers are becoming more optimistic about inflation coming down. The Survey of Consumer Expectations for May revealed one-year inflation expectations fell 0.3 percentage point to a 4.1% rate, the lowest annual outlook since May 2021. The survey also found people's expectations of job loss fell 1.3 percentage points to 10.9%, suggesting rising job market strength.
Many leading policymakers have held that the job market could be the key to lowering inflation, asserting workers would have to field lower wage increases to bring inflation back to its target. A new analysis published by the Federal Reserve Bank of San Francisco, however, found that rapid wage growth has not significantly fueled inflation, echoing some doubts from top policymakers about the link between prices and wages.
"I do not think that wages are the principal driver of inflation," Fed Chair Jerome Powell told reporters after the Fed's May policy meeting. "I think wages and prices tend to move together, and it's very hard to say what's causing what."
The analysis, published at the end of May by Adam Shapiro, found labor-cost growth accounts for just 0.1 percentage point of core CPI, excluding food and energy, which rose 0.4% from April to May. This means rising labor-cost growth may not be a strong indicator of inflation outlook. Still, the National Federation of Independent Business found 41% of small-business owners on net raised compensation last month.
"This leaves open other explanations for the high correlation between labor-cost growth and inflation," Shapiro wrote. "For instance, recent evidence shows that wage growth tends to follow inflation, as well as expectations of future inflation."
A World Bank report from last week stated global growth rate is estimated 2.1% this year, down from 3.1% last year. The report noted the US's tightening of monetary policy will particularly impact emerging market and developing economies, or EMDEs, potentially leading to financial crises and recessions around the world.