Fed dots imply another 50bp in hikes this year

The FOMC unanimously decided to keep the Fed Funds rate on hold at 5.00%-5.25% as expected yesterday, but the updated interest rate projections – or dots - were decidedly hawkish.  All but two FOMC members expect rates to rise further this year, with the majority anticipating another 50bp in tightening before year-end, taking the upper bound of the Fed Funds rate to 5.75%. The “skip” in June is to allow more time for the Committee “to assess additional information and implications for monetary policy”.

In his post meeting comments, Fed Chair Powell noted that core inflation remained well above the 2% target and while there has been some progress, inflation is declining much more slowly than the Fed had expected. He also noted that inflation risks are to the upside, given the tight labour market which is supporting high wage growth, and a resilient economy.

The Fed’s updated economic projections show they now expect GDP growth of 1.0% in Q4 2023, up from 0.4% in the March projections. Unemployment is also expected to end the year lower than previously thought, at 4.1%, while the Fed’s core PCE forecast was revised higher to 3.9% from 3.6% previously. The Fed expects core PCE inflation to fall to 2.2% only by Q4 2025. The dots imply four 25bp rate cuts in 2024, with the Fed Funds rate falling to 3.5% (upper bound) in 2025. The market remains more dovish than the Fed, with futures pricing only an 84% probability of a rate hike by September.

The PBOC cut its benchmark one-year medium-term lending facility (MLF) rate to 2.65% from 2.75% previously, in a widely anticipated move. The central bank had cut its one-week reverse repo rate by 10bp earlier this week. The PBOC also injected a net CNY37bn (USD 5.2bn) of liquidity into the economy as looks to provide stimulus after recent lacklustre economic data. Industrial production rose 3.5% y/y in May, down from 5.6% y/y in April, and retail sales growth also slowed last month to 12.7% y/y from 18.4% in April. Fixed asset investment year-to-May came in softer than forecast at 4.0% y/y.       

The ECB is expected to raise its benchmark rates by 25bp today and once again the market will be focused on forward guidance. President Lagarde has indicated that further tightening will be necessary as inflation remains well above target, and we expect one more rate hike after today, taking the deposit rate to 3.75% by the end of Q3.     

UK data was mixed yesterday. GDP grew 0.2% m/m in April, in line with expectations, but industrial production declined by a bigger than forecast -0.3% m/m in April. The services sectors were the main source of strength, offsetting the decline in manufacturing output.

Today’s Economic Data and Events

• 16:15 ECB deposit rate forecast 3.5% (3.25% previously)
• 16:30 US retail sales (May) forecast -0.2% m/m (0.4% m/m previously)
• 16:30 US initial jobless claims (10 June) forecast 245k (261k previously)
• 16:30 US empire manufacturing index (Jun) forecast -15.1 (-31.8 previously)
• 17:15 US industrial production (May) forecast 0.1% m/m (0.5% m/m previously)