The US Federal Reserve (Fed) left rates unchanged as expected, maintaining the Fed funds target range at 3.5 - 3.75 per cent. In the statement, the Committee (FOMC) decided to remove the forward guidance it provides to markets, instead moving to a fact-based characterisation of the economy that emphasises resilient growth dynamics as a result of productivity gains, and “elevated” inflation driven by supply shocks.
The Committee also made a definitive statement about “delivering price stability” which reads hawkish given the extent to which the Fed has overshot its inflation target over the last five years.
This statement did achieve unanimous backing from the Committee, a significant improvement from the three dissents we saw at the last meeting. However, the most hawkish surprise came from the fact that nine out of the 18 committee members pencilled in the need for hikes this year, with six committee members pencilling in two or more hikes. This significant shift can be explained in part by a large move up in expectations for inflation from the vast majority of the Committee, indicating that it expects to miss its inflation target again this year.
Kevin Warsh’s first press conference is likely to be looked back on as one of the most consequential press conferences in this new era of Fed policy.
Firstly, he reiterated the Committee’s commitment to price stability, saying that the Committee was ambiguous and unanimous in its commitment to it.
Secondly, as expected, he vehemently refused to provide any forward guidance, instead giving a factual characterisation of the Summary of Economic Projections (SEP) and focusing the majority of his time on his regime initiatives for the Federal Reserve. These five task forces span the gamut of monetary policy, and in his view, are expected to complete by autumn/year end.
The task forces are likely to serve two purposes. Firstly, they provide a clear shield against calls for earlier hikes, with Warsh able to point to the need to complete the task force work, before they can take action. Secondly, they will give Warsh lots of opportunities to change the operating parameters of the Fed. The effect of these changes will have to be judged in the fullness of time, but it is particularly notable that he seems to be leading the data task force, potentially giving Warsh the opportunity to skew the measurement of inflation dovish, if he so chooses.
Given this extreme lack of clarity on the Fed’s near-term direction, we believe Warsh’s more philosophical statements reveal a hawkish bias.
Firstly, he reiterated his long-term mantra that “inflation is a choice“ and said repeatedly that the Fed is “going to deliver” price stability.
He made hardly any mention of the employment part of the Fed mandate, the part that has often led the FOMC to take a more dovish stance than a pure inflation-focused central bank might take. Taken together, we believe they reveal an underlying hawkishness in Warsh’s reaction function, a stance that markets also assessed, with both the two-year yield and the dollar rising.
Looking ahead, as markets increasingly focus on the potential for de-escalation in the Middle East, the outlook for interest rates for the rest of the year will be driven primarily by how the domestic US economy continues to evolve. Our base case still sees the US economy continuing to exhibit significant growth momentum as a result of the AI capex build out.
Given this strong growth trajectory, combined with a labour market that is seeing re-accelerating strength and tightening, our baseline inflation forecast sees inflation continuing to increase to around 3.5 per cent by the end of the year.
Given this reflationary backdrop, we expect the broader Fed committee to continue to build for the need for rate hikes this year. While we expect Warsh to be able to initially push back on this pressure, pointing to the need for his various task forces to deliver their findings, if this inflationary pressure still exists after the midterm US elections, we expect the Fed to have to begin a hiking cycle.
