Financial markets are pricing in another pause by the Reserve Bank of Australia when it meets today, but when it comes to interest-rate hikes in the US, it’s not quite over yet.

A quarterly uptick in a widely watched measure of wage inflation all but ensures the Federal Reserve Board will raise its benchmark federal-funds rate by a quarter of a point when officials sit down to meet this week.

The Employment Cost Index released by the Bureau of Labor Statistics Friday showed wages and salaries rising by 1.2% in the three-month period ended in March from the previous quarter.

“It was a larger and hotter print than last quarter and above consensus estimates,” says Jeff Schulze, investment strategist at Clearbridge Investments. “It’s the final nail in the coffin for another rate hike.”

According to the CME FedWatch Tool, which tracks bets on the direction of interest rates in the futures market, the odds of a quarter-point rate hike are 86% at the May meeting.

The widely expected May rate increase would mark the 10th straight rate hike in the past year as the Fed tries to wrestle control of stubbornly high inflation.

A line chart showing the effective federal-funds rate and the 2- and 10-year treasury yields.

Bank lending standards and credit conditions will also inform the Fed’s decision. The Fed-conducted Senior Loan Officer Opinion Survey on Bank Lending Practices—sometimes known as the SLOOS report—measures the availability of credit.

The SLOOS report is scheduled to be released the week following the Fed meeting, but Fed officials will have access to the latest data.

Bank lending has been tightening for much of the past year, and the recent turmoil in regional banks triggered by the mid-March collapse of Silicon Valley Bank and Signature Bank, in addition to ongoing woes at First Republic Bank (FRC), has likely caused more of a pullback. Demand for credit has also dipped.

The Fed will also be looking at weekly bank data to determine if deposit outflows have stabilised as well as looking at the number of banks turning to the Fed’s lending facilities, typically a sign of stress.

Will the Fed Pause After May?

However, what happens at its June meeting and beyond is a matter of debate. About 70% of market participants expect the Fed to pause in June, according to CME FedWatch. Morningstar’s Preston Caldwell expects the Fed to pause its rate increase by summer and start lowering rates around the end of the year.

Clearbridge’s Schulze is also among those who think a pause will be in order, especially given the uncertainty surrounding the negotiations between the Biden administration and Congress to lift the debt-ceiling cap on government borrowings to pay expenses. Also, he points out, should the Fed raise rates by 0.25 percentage points this week, it will bring rates to the level the central bank has indicated is the terminal rate to achieve its goals for a balanced economy.

Given the Fed’s projections for unemployment to reach 4.5% by the end of this year, Schulze is forecasting a recession later this year, another reason to pause.

Citing the Sahm Rule, a Fed-tracked indicator named after former Federal Reserve economist Claudia Sahm, Schulze says an increase in the three-month unemployment rate of 0.5 percentage points or more from a low in the previous 12 months signals the start of a recession.

“The easy part of fighting inflation was bringing it from 9% to 5%,” says Schulze. “Now the hard part is getting it from 5% to 2%. A weaker labor market is the key to that.”

Vanguard’s Patterson, on the other hand, sees a recession coming later this year but also sees rate hikes continuing in the near term.

“There’s still a lot of work to be done,” says Patterson. “We see rate increases in June and after. The Fed will continue to focus on inflation and wages and rightly so. Our base case is for a recession in the second half of this year.”

While the market is pricing in rate cuts as early as September, Patterson says “rate cuts are a 2024 discussion.”