Key Takeaways
- The Fed’s decision to hold rates steady at 3.50%–3.75%, following 75 basis points (bps) of cuts late last year, signals a continued data-dependent pause rather than urgency to adjust policy despite geopolitical and inflation uncertainties.
- Resilient labor market conditions and still elevated core inflation, exacerbated by recent energy price increases, leave the Fed balancing its dual mandate while likely looking through temporary geopolitical-driven price shocks.
- With Kevin Warsh poised to become the next Fed Chair, markets may need to recalibrate expectations, as policy is likely to remain data-driven with the easing cycle approaching its conclusion rather than accelerating further cuts.
For the third consecutive policy gathering, the Federal Open Market Committee (FOMC) decided to remain ‘on hold,’ keeping the fed funds trading range at 3.50%–3.75%. This result was largely expected by the markets. Unfortunately for the Fed, the policymakers are in a challenging position of juggling incoming economic and inflation data as well as the uncertainties emanating from the Middle East war.
Against this backdrop, both the Fed and the broader investment community are left wondering what could come next from a monetary policy perspective. One thing to address at the outset is that despite the surge in energy prices, the Fed will not be entertaining any potential rate increases. Rather, the voting members remain in a data-dependent mode that should continue to argue for a more patient approach to the decision-making process. This last point is underscored by the fact that the FOMC just cut the fed funds rate by 75bp from September through December of last year. In other words, it is not as if the Fed is ‘behind the curve’ at this point.
In terms of future Fed policy decisions, it appears as if the money and bond markets now have two factors to consider: the usual employment and inflation backdrop, and now what appears in all likelihood of a Fed Chairman Kevin Warsh.
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Let’s examine the latter consideration first. The recent news whereby the Department of Justice (DOJ) is ending its criminal probe of current Fed Chair Powell now puts Warsh’s nomination process on a clearer glidepath for confirmation. Indeed, Senator Thom Tillis has indicated he will no longer ‘block’ the nomination process and will support Warsh to become the next Fed Chairman. As a result, barring any unforeseen circumstances, it would appear that Kevin Warsh will, in all likelihood, be the Chair at the next scheduled FOMC meeting on June 17.
Despite a de-escalation in the Middle East war, as of this writing, geopolitical events continue to foster an uncertain setting.
As far as the Fed’s dual mandate goes, new job creation rebounded in a visible fashion in March, and broadly speaking, the employment landscape still looks like it is in a ‘no hire, no fire’ zone. Importantly, jobless claims remain historically low and reside at levels that have not been associated with economic downturns in the past. From the inflation side of the equation, price pressures remained above the Fed’s preferred level. Indeed, the Fed’s preferred core PCE Deflator gauge was still a full percentage point above the Fed’s 2% target prior to the Middle East war. In addition, the March CPI data revealed the first effects of higher energy prices on overall inflation.
The Fed will probably ‘look through’ the recent surge in energy prices. Yes, this development has created a noteworthy shift in inflation fears, but if there are no future ‘challenging’ Middle East headlines, oil and gasoline price increases could move lower quickly, but perhaps not fully back to their pre-war levels.
The Bottom Line
Back to a Warsh-led Fed. If investors are expecting the new Chair to embrace immediate rate cuts, they will probably be disappointed. A Chairman Warsh will be making monetary policy decisions based on the data. The important point for the prospective investment backdrop: rate cuts are either near or at the end of this easing cycle.
Kevin Flanagan, Head of Investment and Fixed Income Strategy
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