End Of The Line?

By Bas can Geffen, senior macro strategist at Rabobank

The Fed’s decision to hike by 25 basis points was unanimous and widely expected. Initially, equity markets rallied on the news, as the FOMC statement was largely unchanged. However, that move retraced during the press conference, leaving the S&P 500 virtually unchanged on the day.

The only change of note in the statement was a slightly more upbeat assessment of the economy, with the text now reading that “economic activity has been expanding at a moderate pace”, replacing the earlier assessment of “modest” growth. Yet, the FOMC clearly remains in data-watch mode. As such, Powell kept his options open for September. At the press conference the chairman reiterated that the June and July decision do not establish a pattern: the communicated “gradual pace” does not necessarily mean that the Fed will only hike every other meeting; hiking two out of three meetings could also be considered gradual in his view. In other words, a hike in September would still be possible if the data require the FOMC to act.

With that, Powell has raised the upside risks to our baseline view that the Fed is effectively done hiking after yesterday. As Philip Marey, our US strategist, explained prior to the decision, we expect a rebound in headline CPI inflation in the coming months due to base effects, but by contrast we expect a gradual decline in core inflation – though core inflation will probably remain elevated for the remainder of the year.

At the same time, we think it is premature to declare a soft landing, and we could still see the US economy slip into recession in the second half of the year. However, the US policymakers do not anticipate a recession, and Powell said yesterday that the Fed’s staff no longer anticipates one either. So the FOMC may decide to skip September, in favor of hiking in November. In that scenario, we believe that this hike could be thwarted by the deteriorating economic outlook.

Obviously, our forecast for the Fed funds rate is data-dependent. And because in real terms monetary policy has only recently become restrictive, we are sympathetic to more rate hikes. Disappointing data on core inflation could still convince the Fed to go ahead in September. However, because of the “more moderate pace” of monetary tightening we doubt if additional hikes will materialize.