How I Predicted the June Pause in Interest Rate Hikes back in April
(It is all in Chair Powell’s words)
On April 5th at 4:03 PM Arabian Standard Time (AST) I sent a text to my work group chat to document my prediction that the FOMC will vote to keep rates constant in June, and here is a SHORT summary of how I came to that prediction.
Disclaimer: The FOMC vote was a very close one. This post could just have easily been a post about how my prediction was WRONG. Really good arguments could be made for keeping rates constant AND raising rates one more time.
Essentially the main question is this: “Has the economy shown sufficient evidence of inflation slowdown while maintaining a tight labor market?”
In other words, do the FOMC members have proof that the last 10 rate hikes are sufficiently working to bring down inflation and that they can afford to skip a rate hike for the sake of assessing the impact of the policy calibration?
I believe that a fair argument could be made both ways. Here is a summary of why I believed they would pause in June based on the Fed’s Forward Guidance in the press conferences following March and May FOMC meetings.
March 2023:
The FOMC in March was not a typical meeting as it came after the bankruptcy of Silicon Valley Bank (SVB) and Signature Bank (First Republic was in distress). We were all waiting to see how, and if, the FOMC would react. In his press conference, Chair Powell was quick to address the developments in the banking sector. He implied that they were isolated problems that have not spread to the rest of the system.
(He went on to clearly state that if they were left unaddressed, however, they could negatively impact the confidence of the banking system consequently creating wider spread liquidity problems.)
The FOMC went through with raising rates in March seeing as the “banking system is sound and resilient”, “inflation remains too high” and “the labor market remains extremely tight”.
(1) Except, right after announcing the rate hike, Chair Powell stated that economic indicators were “stronger than expected”. To me, this meant that they expected not to see comforting and sufficient evidence of falling inflation (necessitating many more rate hikes), BUT THEY DID START SEEING SIGNS.
(2) Chair Powell also acknowledged that the events in the banking sector would have contractionary effects on economic outcomes. Meaning, the small bank crises, and liquidity shocks would work in the same direction as contractionary monetary policy and are likely to increase the momentum of the economy’s response to the policy.
This prompted the committee to change their statement
“We anticipate that ongoing rate increases will be appropriate to quell inflation”
To:
“We anticipate that some additional policy firming may be appropriate”
To me, that meant that the Fed is no longer pre-emptively leaning towards raising rates, rather, they could possibly reinforce the policy they have already set. My interpretation of “policy firming” is pausing the rate hikes and using forward guidance to continue to anchor inflation expectations and guide the public’s expectations of future policy decisions.
(3) Summary of Economic Projections (which summarized each FOMC member’s expectations on economic projections and policy calibration) showed that the median participant’s projection of the appropriate level of the Federal Funds Rate is 5.1%. In March, the Federal Funds Rate had reached 4.75%-5.00%. These SEP projections hinted at a pause soon since the Federal Funds Rate has –somewhat- reached the committee’s expectations of an appropriate interest rate.
May 2023:
(4) In previous press conferences, the speech’s tone would be to announce that “inflation is not showing encouraging signs of slowing down, and seeing as the labor market is still tight, we will raise rates”. A statement like this would be followed up with a statement like “and in the future we are ready to adjust the path for policy if the economy does not evolve as projected.
However, the tone in May was different. Chair Powell announced that rate hike and immediately followed it up with “Looking ahead, we will take a data-dependent approach in determining the extent to which additional policy firming may be appropriate”.
It felt like the committee was running a marathon for the past 10 rate hikes, looking for a sign to stop running, and in May they thought “maybe we should look around and see where we are”.
(5) Chair Powell also went on to hint at time lags stating, “It will take time for the full effects of monetary restraint to be realized”. He also stated that the events in the banking sector in March are continuing to cause tighter credit conditions for households and businesses, but “the extent of these effects remains uncertain”.
There is always a time lag between implementing a policy and seeing its effect. The Fed has raised rates in the last 10 meetings and it is highly unlikely that the American economy has felt the full consequences of them or the consequences of the events in the banking sector.
Chair Powell stated “Our future policy actions will depend on how events unfold”
And here is what that meant to me:
“We recognize that there are time lags for monetary policy, but inflation was so devastating, that we could not afford to wait and see. It was necessary for us to raise rates until we are confident that the effects are starting to be realized by the economy. Since we are seeing the effects of tighter policy on interest-rate sensitive sectors, we are hoping that the next inflation projections will be sufficient enough for us to trust that we can pause, and assess the current situation.”
This is the first time this tone has been used since the committee started raising rates.
(6) The statement mentioned above :
“We anticipate that some additional policy firming may be appropriate”
Was changed AGAIN to:
“In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the committee will take into account certain factors”
Removing the word “anticipate” is powerful. It means that the Fed will no longer anticipate decisions, but rather be fully data-driven. So, Fed is confident that they are reaching a time when the next move could be a rate hike equally as much as it could be a pause.
But the next decision (June) would be a pause and I could feel it.
