Fed may be forced to defy market expectations and hike more aggressively, economist says

Traders react as Federal Reserve Chair Jerome Powell is seen delivering remarks on a display, on the ground of the New York Stock Exchange (NYSE), May 3, 2023.

Brendan McDermid | Reuters

The U.S. Federal Reserve may be forced to defy market expectations by mountaineering rates of interest aggressively once more later this 12 months if sticky inflation and tight labor markets persist, in accordance to Daniele Antonucci, chief economist and macro strategist at Quintet Private Bank.

Having hiked by 25 foundation factors to take the Fed funds price into the 5%-5.25% goal vary earlier this month, the market is pricing round a 60% chance that the central financial institution pauses its financial tightening cycle at its June assembly, in accordance to the CME Group’s Fed Watch tracker of costs within the fed funds futures market.

The Fed has been mountaineering quickly over the previous 12 months in a bid to rein in sky-high inflation, however the market expects policymakers to start chopping charges earlier than the tip of the 12 months. Annual headline inflation fell to 4.9% in April, its lowest for 2 years, however stays properly above the Fed’s 2% goal.

Meanwhile the labor market stays tight, with jobless claims rising however nonetheless at traditionally low ranges. Job growth also hit 253,000 in April regardless of a slowing financial system, whereas unemployment sat at 3.4%, its joint-lowest degree since 1969. Average hourly earnings rose 0.5% for the month and elevated 4.4% from a 12 months in the past, each increased than anticipated.

Antonucci instructed CNBC’s “Squawk Box Europe” on Friday that Quintet disagrees with the market’s pricing of price cuts later within the 12 months.

“We assume this can be a hawkish pause — it isn’t a pivot from hawkish to dovish — it is a pause, the extent of inflation is excessive, the labor market is tight, and so markets can be disenchanted if the Fed would not decrease charges,” he mentioned.

Given the energy of the labor market, Antonucci urged {that a} price minimize “appears an implausible state of affairs and it is just the primary subject.”

“The second one is that the stress right here is that if the labor market stays robust, if financial exercise would not ultimately deteriorate to a degree to have a recessionary atmosphere and disinflation, the Fed may have to tighten coverage more aggressively and then you have got a recession together with an earnings recession,” he added.

“The Fed may want to hike more aggressively if inflation stays elevated.”

Antonucci’s place mirrored messaging from some members of the Federal Open Market Committee (FOMC) this week, who’ve reiterated the significance of ready to monitor the lagged impact of prior price hikes but in addition indicated that the info doesn’t but justify a dovish pivot.

Cleveland Fed President Loretta Mester mentioned Tuesday that the central financial institution will not be but on the level the place it may possibly “maintain” charges, whereas Dallas Fed President Lorie Logan urged on Thursday that the info up to now doesn’t justify skipping a price hike on the June assembly.

Investors will be carefully watching a speech from Fed Chairman Jerome Powell on Friday for clues as to the FOMC’s potential trajectory.

“Jerome Powell has been significantly vital of the ‘cease and go’ financial coverage within the 1970’s that contributed to the stagflationary underpinning of the financial system, and which required an aggressive financial coverage to restore worth stability,” mentioned Quincy Krosby, chief world strategist at LPL Financial.

“If he mentions this when he speaks on Friday, the market may interpret it as sign that except the info improves markedly concerning inflation, he’ll advocate one other price hike.”

Krosby added that the week’s “Fedspeak refrain” has served to remind markets that the central financial institution’s mandate is to restore worth stability, and that the FOMC is ready to increase charges once more to “get the job completed if inflation would not cooperate.”

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