Divided Fed expected to rally around a US interest rate pause

WASHINGTON  -The US Federal Reserve is widely expected to pause its campaign of interest rate increases on Wednesday to give policymakers more time to assess the economic impact of existing hikes and recent banking stresses.

But members of the rate-setting Federal Open Market Committee (FOMC) remain divided going into the meeting on June 13-14, with a minority still pushing for an 11th straight hike to fight inflation, which remains stubbornly above the Fed’s long-term target of two percent.

The Fed has raised its benchmark lending rate by five percentage points since March last year, lifting it to between 5.00 to 5.25 percent.

“I think there is enough support within the community for that pause,” EY senior economist Lydia Boussour told AFP.

“But at the same time, the compromise will be that the FOMC will be keen on carrying on retaining that optionality, and really keeping the door open to further tightening,” she said.

Fed raises rates, opens door to pause in tightening cycle

Corralling the cats

Senior officials including Fed chair Jerome Powell have indicated they may vote to hold the benchmark lending rate at the next meeting of the Fed’s powerful rate-setting committee, while leaving the door open to an additional rate hike in July if necessary.

“Skipping a rate hike at a coming meeting would allow the Committee to see more data before making decisions about the extent of additional policy firming,” Fed governor Philip Jefferson said late last month.

The data points to a mixed economic picture, with slowing growth, a tight labor market, and inflation still well above the Fed’s two percent target.

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Jefferson, who was recently nominated for the vacant number two spot at the Fed, added that “a decision to hold our policy rate constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for this cycle.”

But those pushing for a further hike, like Fed governor Christopher Waller, have indicated support for a more aggressive stance on inflation.

“I do not support stopping rate hikes unless we get clear evidence that inflation is moving down towards our two percent objective,” Waller said last month, adding: “whether we should hike or skip at the June meeting will depend on how the data come in” before the next decision.

The division among members of the FOMC over the best path forward has led some traders on a journey, from predicting a pause to expecting a hike — and back again.

Futures traders who as recently as late May were predicting another hike, now see a more-than 70 percent chance that the Fed will vote to hold rates on Wednesday.

And many analysts now also see a pause as the most likely scenario on Wednesday.

“Chairman Powell is expected to corral the cats and get the Federal Open Market Committee (FOMC) to skip a rate hike in June, while leaving the door open to hike in July,” KPMG Economics chief economist Diane Swonk wrote in a recent note to clients.

While most major banks now predict a pause, there are still some notable outliers who expect the Fed to hike rates by another quarter percentage point.

“We are maintaining our call for a 25bp rate hike next week – though admittedly it is a close call,” Citi economists wrote in a recent investor note.

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If Powell does succeed in winning over a majority of FOMC members for a June pause, analysts expect the Fed to signal through its interest-rate announcement and updated summary of economic projections (SEP) that it expects another rate hike to complete the cycle.

“Among the key innovations for this meeting, we expect the statement will be hawkishly adjusted to note the potential for further tightening at ‘coming meetings,'” Deutsche Bank economists wrote in a note to clients.

The SEP will likely show that “appropriate policy may require an additional hike to achieve a “sufficiently restrictive” stance,” they added.

This, analysts say, would help the Fed leave the door open for an additional rate hike if needed, possibly as early as July.