Morningstar Investor users sign in here.

Markets

US Federal Reserve to hike this week as markets price in RBA pause

But whether the Fed pauses, or even cuts rates this year, is very much up for debate.

Co-Author | Jakir Hossain

Mentioned: First Republic Bank (FRCB)


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.”



© 2023 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This report has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or New Zealand wholesale clients of Morningstar Research Ltd, subsidiaries of Morningstar, Inc. Any general advice has been provided without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide at www.morningstar.com.au/s/fsg.pdf. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782.

More from Morningstar

Global Markets Report - 1 December
Markets

Global Markets Report - 1 December

ASX set to open lower, while US major indices break a three-month losing streak for November.
Global Markets Report - 30 November
Markets

Global Markets Report - 30 November

ASX set to open higher, after a mixed day for US major indices and bond yields continued to move lower.
2024 themes for investors
Markets

2024 themes for investors

Morningstar’s 2024 Outlook report names three swing factors that may result in a wider range of outcomes. 
Global Markets Report - 29 November
Markets

Global Markets Report - 29 November

ASX set to open higher, after US stocks posted small gains as investors bet on Fed rate cuts in the first half of the year.
Global Markets Report - 28 November
Markets

Global Markets Report - 28 November

ASX set to open higher, after a subdued session on Wall Street saw all major indices close slightly lower.
Global Markets Report - 27 November
Markets

Global Markets Report - 27 November

ASX set to open higher, after Wall Street reopened with modest rises for all major indices following the Thanksgiving holiday.