Comments from Erik Weisman, Chief Economist and Portfolio Manager, MFS Investment Management
The Fed is right where it should be right now. Congratulations are in order, as the central bank has managed to increase interest rates to its desired target and largely price out cuts for the rest of the year without toppling the US economy, at least not yet. While market pain in 2022 was difficult for both equity and fixed income investors broadly, it was necessary to restore rates to a more normal level. And of course, this is exactly the moment when the policy mistake can happen. Continued policy rate increases run the risk of driving up costs throughout the economy and making an inevitable slowdown worse, while ignoring any further need to keep hiking could also allow inflation to persist at higher rates and see the economy overheat instead of slowing down.
In short, the market is pricing in about an 80% chance the Fed raises rates by 25bps in July. This is reasonable and barring unforeseen upside risks in inflation and labor markets, it would likely to be the last hike. Inflation continues to come down and we expect YoY% core CPI inflation to be below 4% by the end of the year, with headline inflation potentially falling into the high 2s or low 3s as well. When it comes to unemployment, it continues to be near record lows, and while starting to bump up, it is still not yet signaling any immediate concerns. Furthermore, we don’t think the recent rate increases in Canada and Australia will spook the Fed, nor do we anticipate the release of CPI just prior to the Fed meeting to impact the June pause either.
Also read: Five High Yield ETFs to Beat Inflation
We would like to hear a more definitive Fed chair speak with conviction, offering remarks that are less about what could happen and instead be more in line with where we are today. Furthermore, the Fed would be well-served to remind the market to not get ahead of itself regarding eventual rate cuts. An inconsistent message from the Fed next week runs the risk of undoing what it has achieved since the rate hiking regime began in January 2022. If the central bank allows the market to think rate cuts are just around the corner, it will send the wrong signal to the equity market before we ever get an anticipated economic slowdown or recession in the US.
