The Fed’s May Statement

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Hikes… Take a Hike

Markets came into today’s FOMC meeting pricing a 99.5% probability of the Fed holding policy rates steady, and there were no surprises on that front. What markets have been cueing from  recently though, was the possibility of a rate hike being mentioned. That didn’t happen. In fact, great effort was made to reinforce that a hike was quite unlikely in the months to come.

Sometimes the removal of a risk is received just as warmly as the addition of a positive.

Markets got what they wanted out of the meeting, and the Fed seems to be getting what it wants in the form of cooling growth and a labor market that remains in better balance than a year ago.

In order to defeat inflation and feel more confident in achieving its 2% goal, the Fed has continued to point out the likely need for some cooling, and in this meeting Powell acknowledged that the process can be inconvenient.

The most recent GDP data showed 1.6% growth for the first quarter, which is below trend, and quite a bit below the 3.4% from the fourth quarter. Although not mentioned today, Powell has historically said that a period of below trend growth was necessary in order to achieve their inflation goals. Inconvenient for those who were betting on a continuation of 3%+ GDP growth, but exactly as planned in order to reach the final destination.

Although it has taken longer than expected for some of this cooling to show up in the numbers, I interpret much of this as what the Fed hoped would be our return to “regular programming”.

But as Powell pointed out today, it requires more than one data point to convince them to take a stance. Which means there’s no hurry to do anything now, nor in the foreseeable future.

Can’t Catch a Break

Much has been made of the progress in inflation since its peak in mid-2022, as well as the resilience of consumer spending in the face of stubbornly higher prices on goods and services. But we’re starting to hear rumblings of a consumer that’s feeling tapped out, and inflation indicators that are headed back up, such as the Employment Cost Index (ECI).

Although PCE has come down, which is the Fed’s metric of choice, we know there are other measures still putting pressure on consumers, and the ECI which is putting pressure on employers.

First quarter earnings season isn’t over yet, but already we’ve heard from a number of large consumer-facing brands that discretionary spending has weakened, with customers not as willing to absorb higher prices as they were in past quarters.

It’s easy to take that and start to panic that the consumer is cracking. Instead, what market participants and the Fed are likely hoping for is consumers who don’t overspend, which would keep inflation high and put them in an unsustainable position. Perhaps that’s what’s going on. All weakness is not bad weakness, some is necessary in order to make the economic environment work for more people.

The ECI read does require a careful watch, however. If employment costs remain high at the same time as the consumer slows down to protect their spending, it could translate into margin contraction and weaker earnings growth. Given that the market is currently expecting double digit EPS growth in 2024, this risk is worth noting.

Enjoy the Pause

Despite what markets feared, not much changed in this FOMC meeting. Cuts are still further out, economic data is still decently solid, and the Fed isn’t overly concerned about its ability to eventually achieve its inflation goal.

Enjoy the pause while it lasts.

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