Breitbart Business Digest: The Market Still Doubts Fed's Inflation Resolve

Jerome Powell Has Not Won Over the Market Yet

Wall Street still wants to fight the Fed.

The Federal Reserve’s policymakers at yesterday’s meeting revised up their estimates for year-end interest rates from 5.1 percent to 5.6 percent, which would translate into a policy range of 5.50 percent to 5.75 percent. The “dot plot” shows that nine Fed officials have forecasted that level for rates and three have forecasted a higher level. Just six officials have predicted rates lower than that, and no one has predicted anything lower than the current level.

The other revisions in the Summary of Economic Projections were largely consistent with this view. The median projection for core inflation was revised up (although headline inflation was revised down slightly), as was the projection for economic growth. The projection for unemployment was revised down. So, the Fed appeared to be sending the signal that the economy is expected to continue to be resilient, making it better able to withstand further rate increases.

The bond market has consistently underestimated the Fed’s rate increases for two years. Some investors have thought, as the Fed itself once did, that inflation would be “transitory” and therefore not require too many hikes. Others thought the economy would be more vulnerable to rate hikes, entering a recession late last year or early this year. And still others just doubted the determination of the Fed to bring down inflation, predicting that the Fed would not just back off from increasing rates but start cutting to fend off a downturn.

The reaction to Wednesday’s announcements and Chairman Jerome Powell’s press conference suggests this is still happening. Markets and analysts are no longer forecasting a series of rate cuts this year, but they do not buy the notion that the Fed will hike to a range of 5.5 to 5.75 and keep it there through the end of the year. The CME Group’s metric based on prices of fed funds futures currently estimates just under a seven percent chance that we end the year at the median forecasted range, with no chance that we end higher.

The outcome most favored by the implied odds is one quarter of a point higher than the current target. The probability of that is estimated to be around 44 percent. After that is rates ending the year at their current level, with a 39 percent probability. A quarter-point cut is still getting a 10 percent probability, higher than the odds that we hit the median Fed projection.

The Bloomberg consensus forecast is based on estimates issued before the Fed’s meeting, but it also suggests a skepticism that the Fed will follow the projected path. It shows rates at year’s end being where they are today. When updated, it is unlikely to show more than a quarter point hike.

“Why the gap?” Bank of America’s Ethan Harris asked in a note on Thursday morning. “In our view, both the markets and the consensus are under-estimating the anti-inflation resolve of the Fed. When inflation is a serious problem, the Fed will not cut at the first sign of recession. Indeed, the doves on the committee have voted for every rate hike, including lumpy 75 bp moves, a hike at the peak of bank stress and a hike in front of the debt ceiling deadline. These folks are serious.”

Fed No Longer Sees 2023 Recession

When the Fed released its earlier set of projections back in March, we noted that the Fed appeared to be forecasting a recession. The Fed was projecting fourth-quarter to fourth-quarter growth of just 0.4 percent even though the economy appeared to have grown by at least one percent in the first quarter of the year. To us this signaled that the Fed believed we were in for two consecutive quarters of contraction later in the year to drag the full year down to four-tenths of a percent.

That’s no longer the case. The latest projections have the economy growing 1.1 percent this year. That’s below the Fed’s long run estimate of 1.8 percent growth—but not that far below. More importantly, it looks achievable with sluggish growth in the third and four quarter after a surprisingly robust second quarter. So, there is no longer an assumption of contraction built into the numbers.

If you look at the range of growth estimates, it is striking how much more bullish on the economy the Fed has become. At the March meeting, estimates ranged from -0.2 percent to two percent. The new projections lift the bottom of the range all the way up to positive 0.5 percent and the top of the range to 2.2 percent. We don’t get dot plots for the GDP projections, but it is striking that no one on the Fed is expecting a full-year contraction.

Americans Are Still Spending More

That bullishness on the economy got some support on Thursday from the better-than-expected retail sales numbers. Sales were expected to contract in May, with many economists doubting our Easter rally thesis and convinced that there would be pullback after April’s 0.4 percent surge. Instead, consumer sales rose by 0.3 percent. If you exclude gas station sales (which were depressed by the decline in gas prices), consumer sales were up 0.6 percent.

As we said the other day on Larry Kudlow’s Fox Business show, consumer sales are likely to stay strong so long as the jobs market remains strong. That, in turn, is likely to continue to prop up inflation and higher interest rates.

With the consumer price index rising just 0.1 percent and core inflation up 0.4 percent in May, a good deal of this spending looks real and not just nominal. So, Americans are actually buying more, not just paying more for the same volume of goods and services.