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The FOMC meeting is in.

After the Fed left rates unchanged, many are left with one lingering question though:

"Pause" or "Skip"?

We had two significant data points last week with both the CPI and FOMC. For such large macro releases, we didn't quite see the fireworks of old.

Market reaction was mostly hesitant, waiting for direction.

Have traders packed it in for the summer and left for their vacation homes?

With inflation cooling and an end to hiking in sight, many are turning to recession watch. Earnings and earnings growth will be the key for H2 as the Fed looks to thread the needle.

Did JPOW pull off his best Maverick imitation? Will we get the "soft landing" everyone is dreaming about?

Only time will tell.

This week, in <5 minutes, we’ll cover CPI & FOMC Recaps:

• CPI Print 👉 By The Numbers

• FOMC Meeting 👉 Decision, Dots, Deliberation

• Pause or a Skip 👉 Will We Get a July Hike?

Let’s get started!

1. CPI Print 👉 By The Numbers

The CPI rose 0.1% in May, taking the year-ago increase from 4.9% in April to 4.0% last month (below expectations).

Core CPI (ex-food and energy) was up 0.43%, bringing the year-ago figure from 5.5% in April to 5.3% in May (above expectations).

Big picture – there weren't many surprises that drastically altered the Fed's POV.

The table below breakdowns the numbers:

Digging into the details, the headline figure was held down by a 5.6% decline in gas prices. Food was up 0.2%, a touch more than in March and April. Not a bad outcome!

Core goods prices increased by 0.6% last month. Almost all of that was due to a second straight 4.4% increase in used car prices.

Core service prices rose by 0.4% last month.

The two rental measures were up by 0.5% (which is high), but they're below what was registered last year.

Core services excluding rent (JPOW's super-core) increased by 0.24% last month. For context, in the two decades before the pandemic, this measure increased by an average of 0.23%. Within the super-core, airfares and medical services were soft, but prices for lodging away from home popped.

One thing to highlight is the green bar in the chart above, which represents shelter. Shelter now has an even more outsized contribution to inflation.

Don’t forget though, this is a lagging indicator!

Check out this great chart from Charlie Bilello on the outstanding mortgage mix:

Two things are happening that continue to restrict housing supply:

1. People can’t afford to move.

2. Staying put is a better long-term option for building wealth.

Those who secured mortgages when rates were low are unable to handle the higher rates. Monthly debt service burdens have nearly doubled, which also affects mortgage qualifications.

Even if they can afford to move, having a lower rate will lead to much better long-term wealth creation outcomes. It makes sense to stay put. Many people forget that the US offers 30-year fixed-rate mortgages, unlike places like Canada where mortgages often renew every 5 years.

Would you give up 3% right now? I wouldn't.

These dynamics dry up the existing home sale supply and contribute to more "stale" pricing in the housing market.

The result? A more "illiquid" market where price discovery isn’t as efficient.

In the existing home sales chart above, there's an '08-type collapse in sales. I'm not saying pricing will collapse to 2008 levels, but sales have declined significantly due to the structure of the mortgage market.

This is something to closely monitor.

Overall, this CPI print supports a constructive view on the economy and markets.

While this was largely expected, next month's print may have a more significant impact. We should expect another notable decrease in headline inflation (around 3.0%?). This will lead the market to debate whether the Fed meeting in July will be another skip or pause.

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2. FOMC Meeting 👉 Decision, Dots, Deliberation

The Fed broke its streak of 10 straight hikes on Wednesday and kept the policy rate unchanged at 5.0%-5.25%. "Nearly all policymakers" still feel more hikes are needed this year though.

No policymakers foresee a cut in 2023.

Although rates were unchanged, JPOW expressed concerns about inflation. He sees more upside risks and believes not enough progress has been made on core PCE (his favorite indicator).

On the flip side, there’s some good reasons to keep rates where they are. May's CPI showed a continued cooling of inflation after 10 consecutive hikes. It probably makes sense to observe how those "long and variable lags" play out.

We also received an updated "Dot Plot." As a reminder, the dot plot is a survey of voting committee members who provide their projections for certain rates at the end of each year.

March Dots:

June Dots:

There was an upward shift in the curve through to 2025 as committee members adjusted their rate projections.

Here's the most important thing though.

The year-end figures for 2023 are projected to reach 5.625. This indicates two more hikes before the end of 2023.

So, was this latest decision a pause or a skip?

3. Pause or a Skip 👉 Will We Get a July Hike?

The dot plot makes it clear – the Fed is indicating rate expectations should be adjusted higher for longer.

Markets are now pricing in a higher likelihood of a 25 bps hike in July. The probability currently stands at 71.1%, vs 60.3% on Tuesday and 50.9% a week ago.

For the September meeting, traders are assigning a 16.7% probability that the fed funds rate will increase to 5.50% – 5.75% vs a 8.8% chance on Tuesday.

WSJ's Nick Timiraos had a question asking why. If the Fed believes another 50 bps of hikes are necessary, why not do it now? JPOW's response was that we are approaching the finish line. Given uncertainties regarding when previous hikes will fully manifest in the economy, it makes sense to take a breath.

Views on "why not hike now?" vary, including:

• JPOW may have had to appease more hawkish parts of the FOMC, hence the strong stance on "higher for longer."

• JPOW believes that rates are already sufficiently restrictive.

• Market-based inflation measures (e.g., inflation swaps) show a more significant decline in inflation and have been more accurate than the Fed's forecasts.

If the Fed needed to send a strong hawkish signal to the market, it would have hiked.

Looking ahead, the threshold for further hikes will be much higher.

So again, has the rate hiking cycle just ended?

Pause or skip?

4. Soft Landing 👉 Growth + Disinflation

A soft landing occurs when there’s a moderate economic slowdown following a period of growth. The goal of the Fed is to achieve this soft landing by raising interest rates to a level that prevents the economy from overheating without causing a severe downturn.

The FOMC has acknowledged both strengths and weaknesses in the economy. Economic activity has been expanding at a modest pace, job gains have been strong, and unemployment has remained low.

However, inflation is still elevated, and tighter credit conditions are expected to have a negative impact on economic activity, hiring, and inflation.

The Fed's updated economic forecast no longer predicts a recession though. They now anticipate GDP growth of 1% (up from 0.4%), unemployment of 4.1% (down from 4.5%), and a slight decrease in PCE to 3.2% (from 3.3%).

A 1% GDP forecast translates to 4.9% nominal growth, while the longer-term average has been ~ 3.5%. This implies stronger top-line growth for stocks, as they tend to be more correlated with nominal GDP rather than real GDP.

The Fed maintains the economy will continue expanding in 2024 and 2025, despite significant tightening in financial conditions.

Can they stick the landing? Only time will tell.

Wrapping Up…

Let’s not forget the Fed was terribly wrong at the start of the inflation climbing period and were caught offside.

Since the central bank’s forecasts have been wrong before there’s still room for policy error.

So what do you think… Pause or skip?

Until next time. Always Yours. Incessantly Chasing ROI,

-Genevieve Roch-Decter, CFA

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