Published on May 27, 2023

Inflation Flames Ignite: Fed Contemplates June/July Rate Hike to Tame the Heat!

• Experts believe the recent surge in inflation increases the likelihood of a rate hike by the Federal Reserve.

• Some critics argue that this move by the Fed is not the right direction to take, as it further raises the odds of a rate hike.

• Before the Federal Open Market Committee (FOMC) meeting, reports on employment and consumer prices are expected to be released.

Further disappointing inflation news could potentially persuade Federal Reserve policymakers to raise interest rates once again. This would provide support for those who argue that more actions are necessary to restore price stability.

On Friday, figures from the Commerce Department revealed that the personal consumption expenditures price index, which is the Federal Reserve's preferred measure of inflation, increased by a faster-than-expected 0.4% in April.

Cleveland Fed President Loretta Mester expressed her belief in a CNBC interview on Friday that based on the inflation data, some tightening of monetary policy will likely be required. She mentioned that all possibilities are on the table for June.

Compared to the previous month, the measure has risen by 4.4% from a year ago, slightly higher than the 4.2% increase seen earlier. When excluding food and energy, the core PCE index, which is another inflation measure, rose by 0.4% compared to the previous month and 4.7% from April 2022.

Diane Swonk, chief economist at KPMG LLP, criticized the direction the Federal Reserve is taking, stating that a hike in July is now a possibility depending on resolving debt ceiling issues.

In an effort to control inflation, officials have raised rates by 5 percentage points over the past 14 months, surpassing their 2% target. Following a quarter-point increase earlier this month, the benchmark rate now stands within a target range of 5% to 5.25%. Fed Chair Jerome Powell mentioned that policymakers have the flexibility to observe the data and the evolving economic outlook.

Before the Federal Open Market Committee's next meeting on June 13-14, policymakers will receive additional information regarding employment and consumer prices. However, there may be hesitancy to raise rates as long as there is uncertainty surrounding the ongoing debt ceiling negotiations in Congress.

Nevertheless, investors have increased their bets on a rate hike in the upcoming month, with the likelihood rising to over 50% from 18% just a week ago. This shift reflects recent hawkish speeches from Fed officials and indications of economic strength. According to the report released on Friday, consumer spending, adjusted for prices, increased by 0.5%, marking the strongest growth since the beginning of the year. Treasury yields saw a surge following the report.

Kathy Bostjancic, chief economist at Nationwide Life Insurance Co., commented that the combination of rising inflation and robust consumer spending increases the chances of another rate hike in mid-June.

However, some Fed officials, such as Atlanta Fed's Raphael Bostic and Philadelphia's Patrick Harker, have emphasized that the impact of credit issues stemming from banking failures has yet to be felt. They also noted that monetary policy operates with a lag, meaning the full consequences of higher rates may not be seen in official data yet.

Derek Tang, an economist at LH Meyer/Monetary Policy Analytics, stated that it will take more to sway policymakers from pausing in June, but the possibility of another hike thereafter has increased. Tang's firm revised their peak rate forecast from 5.1% to 5.6% on Friday. He added that the stronger the data flow, the more likely it is for the next hike to occur in July rather than September.

"Persistence has its limits, and patience will wear thin if the economy continues to boom and bank stress does not worsen," Tang remarked.

Minutes from the May 2-3 meeting indicated that policymakers were uncertain about the extent of additional tightening needed, weighing the slower progress on inflation against the resilient labor market and the potential credit crunch resulting from recent banking turmoil.

Goldman Sachs economists, in a note on Friday, stated their expectation for the Fed to maintain steady rates in June. However, they acknowledged that the stronger-than-anticipated consumer spending and inflation data, along with the varied views among FOMC participants regarding the appropriate policy path, make the decision a close call.

In a statement on Friday, the International Monetary Fund (IMF) suggested that the Fed should raise interest rates by a quarter point to bring inflation back to 2%. The IMF also recommended that policymakers emphasize the need for rates to remain high for an extended period to align financial conditions with the intended policy trajectory, while highlighting that policy decisions will depend on incoming data.

Ethan Harris, head of global economics research at Bank of America Corp, noted that the Fed is clearly dependent on data in its decision-making process. In this uncertain environment, he added, every central bank, including the Fed, will be flexible in navigating the path forward.