There was no surprise among participants that the Federal Reserve decided on one more quarter-point rate hike today, but what raised eyebrows was just how little additional meat there was in the statement as to what we should expect in subsequent meetings. The new overnight rate target ceiling moves up to 5.50%, which represents a cumulative tightening of 5.25% since early last year.

 

 

Some had anticipated that the Fed would indicate in its accompanying statement that it would do another quarter-point at the September FOMC meeting, or that it would provide guidance of another skip that month and further tightening later. The one thing that the Fed did not have today was room for any semblance of dovishness. Employment conditions remain tight, the consumer is healthy and financial conditions are as loose as they were back before the Fed started tightening in March last year. The chart below shows the Bloomberg U.S. financial conditions index (FCI), which is a measure of how accommodative the environment is.  The higher the number, the more accommodative things are and it takes into account a number of variables, such as the yield spreads between corporate and government debt, the level of the S&P500 and volatility. The FCI+ measure adds in items like tech share prices, the housing market and deviations in these from equilibrium levels.

 

 

In addition, the Fed is also quite cautious when it comes to announcing victory in the inflation front. While headline inflation has declined sharply from last summer, core inflation (especially services) remains persistently high. Some analysts also believe that headline inflation might start to re-accelerate into year-end if economic demand conditions stay firm. Based on that, the Fed definitely had a case for today’s hike and could make the same case in September.

 

The lack of guidance in today’s statement and press conference indicates the Fed is split between the need to push against a resilient economy and the reality that lagged effects of past rate hikes may only now be showing up, raising the odds of a recession should rates move too far. True, I can look to things like inventories and slower wage growth as indicators that this slowdown is forming; however, the message is clear – go away for the rest of the summer and come back in September.

 

 

The Pyle Group’s view remains the same though. Regardless of whether there is another rate hike in September or not, market expectations of rate cuts within the next few quarters is way too optimistic. These expectations underpin the lofty valuations in stocks and if the Fed were to raise rates through to the end of the year, these expectations will have to be re-evaluated.

 

On behalf of the Pyle Group, have a great rest of the week. 

Andrew Pyle

 

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