FOMC likely to skip June, but hike interest rates in July, analysts say

The Federal Open Market Committee is expected this week to hold interest rates at a range of 5% to 5.25%, but the revised Summary of Economic Projections will likely signal at least one more rate hike this year.

"We expect the Fed to leave the federal funds rate unchanged although both the post-meeting statement and the dot plot will likely emphasize that inaction this week should be considered 'skipping a rate hike' rather than putting an end to monetary tightening," said David Kelly, chief global strategist at J.P. Morgan Asset Management. "Indeed, Fed communications could explicitly warn of a possible further rate hike in July."

Although Kelly believes cooling data through the July meeting should suggest "no further tightening is warranted."

Others disagreed about the future.

"The Fed will need to remain committed to curbing inflation and be ready to raise the rates again and keep them elevated if necessary," said Emin Hajiyev, senior economist at Insight Investment. Inflation, he said, will dictate policy, calling it "the overriding concern."

Economic resilience keeps stagflation from being its base case, Hajiyev said, although it remains possible.

Tuesday's consumer price index suggests inflation is in "a holding pattern," said Greg McBride, chief financial analyst at Bankrate. So far this year, "little progress [occurred] in core inflation metrics," which remain near 5% on a year-over-year basis, "not a level where the Fed will be comfortable resting for any length of time," he said.

The strength in the labor market and inflation more than twice the Fed's desired level, McBride said, "makes one thing clear — the Fed is nowhere close to cutting interest rates."

If the meeting comes down to a battle between progress in battling inflation and recession risk, he added, "it would seem to be an easy call — there is no need to raise the risk of recession any further to combat an inflation problem that is so clearly fading."

But that's not the message the Fed will send, McBride said. "The post-meeting statement and press conference could reveal some dissent on the committee, with some voting to hike further at this time and others indicating a bias toward tightening again in July."

Padhraic Garvey, ING head of global debt and rates strategy, agreed. "There will be some dissent," he said, but he expects a skip, with the Fed acknowledging the possibility of further rate increases.

A skip, with a hike in June, remains BNP Paribas' Markets 360 team's expectation.

"We think the June decision will be a close call," said BNP Chief U.S. Economist Carl Riccadonna, U.S. Economist Andrew Schneider, and Senior U.S. Economists Yelena Shulyatyeva, and Andrew Husby. "The risk is that Fed Chair Jerome Powell fails to appease the hawks, and the committee ends up hiking in both June and July."

The dot plot will likely offer "a hawkish bias," they said, with the "median 2023 dot to rise to 5.5%, reflecting another anticipated 25 bp hike in the pipeline."

After the expected pause and a hike in July, they said, "by September, we think weakening activity and employment data will lead toward a more enduring pause, with the Fed holding at 5.5% until its first rate cut in March 2024."

While the pause is widely expected, Christian Hoffmann, portfolio manager and managing director for Thornburg Investment Management, said, "the most pressing question is how long we hold from here?"

While investors focus on rates, the economic future seems unsure, he said.

"The Fed is going to be data dependent," Hoffmann said. "Labor and services inflation must come down, but if those numbers remain hot, a July hike is very much on the table."

It's a mistake for the market to not take "the Fed at face value that bringing down inflation is the priority."

Still the Fed "was careful to keep its options open regarding further tightening," according to Wells Fargo Securities Chief Economist Jay Bryson, Senior Economist Sarah House and Economist Michael Pugliese.

Data since its previous meeting have surpassed expectations while financial conditions have held, they noted. "Consequently, some committee members have indicated their preference to raise rates further on June 14," although leadership seems "content" with a skip, they added.

The Wells Fargo economists expect no change in rates, with the suggestion a rate hike in July is in play. "This combination would allow a compromise between officials who believe further tightening is necessary and those who believe it is time to be patient and let the medicine of the past year fully take hold," they said.

They also expect the dots to rise 25 basis points for 2023 — to a range between 5.25% and 5.50% — as well as 2024 and 2025, projections for unemployment lowered, GDP growth increased for 2023, and inflation expectations the same.

While Wall Street hopes that a June skip turns into a pause, Edward Moya, senior market analyst for the Americas at OANDA, said after the CPI report, "a June hold is a done deal and the July FOMC decision should be a coin flip as the disinflation process will likely continue, but signs of stickiness remain."

Inflation is waning, he said, and "some of the leading indicators (car wholesale prices, weakening consumer) support the argument that the disinflation process will continue."

Kathryn Rooney Vera, chief market strategist at StoneX, warns the Fed will not be cutting rates seven times next year — as some analysts expect — "unless companies start to shed jobs, consumption collapses, and recession occurs early in 2024. It is certainly possible. However, economic slowing is not the same as economic recession. Need consumption to contribute negatively and that's unlikely to happen with still-low unemployment rate, rising wages (albeit negative in real terms), and 10 million plus job openings."

With a strong labor market, the Fed will need to continue increasing rates to reach its 2% goal, or else lose credibility, she said. "Recession is an inevitable part of the economic cycle," Rooney Vera noted. "It's not likely this year but could be an end-2024 event."

Recession won't occur without "a real rollover in the labor market."

The Fed is more likely to raise rates in the future than cut, she said, "which the market has clearly taken out of its forecasts."

The economic cycle suggests recession is ahead, Rooney Vera said. "The market right now is conditioned for Goldilocks. It could be in for a rude awakening."