Anticipation is growing for the Federal Reserve’s next monetary policy meeting, scheduled for next week, June 16-17, and many economists converge on the opinion that the Washington institute is in no hurry to increase interest rates. At the center of everything is inflation, which remains the tip of the balance.
A rate increase is now unlikely
The current context highlights how the “closure of the Strait of Hormuz has so far had more limited effects on energy prices than initial fears, while markets appear to continue to incorporate the prospect of a gradual normalization of energy flows across the area, favored by the possible easing of tensions in the Middle East”, observes Richard Flax, Chief Investment Officer of Moneyfarm. In light of these developments, therefore, “it appears unlikely that the Federal Reserve will proceed with an increase in rates during its next meeting, a scenario which also finds broad consensus in market expectations”.
On the other hand, the new president of the FED Kevin Warsh – strongly supported by the number one in the White House Donald Trump, who has more than once pushed for a reduction in interest rates – must deal with a current level of inflation which “makes it difficult to identify, in the short term, conditions compatible with a reduction in the cost of money”, continues Flax.
Inflation remains high but “more moderate” expectations
According to findings from the Bureau of Labor Statistics, in May overall inflation stood at 4.2% on an annual basis, in line with expectations, but still well above the 2% target set by the Federal Reserve and a marked increase compared to the April figure (+3.8%).
The acceleration, recalls the Moneyfarm economist, was mainly determined by the energy component, whose prices grew by around 23% compared to a year ago.
More encouraging, however, is the evolution of core inflation, which excludes food and energy, and is more closely observed by the Fed, and which last month stood at 2.9%, as indicated by analysts, a slight increase from 2.8% in April.
Despite recording an increase on an annual basis, Flax underlines how its dynamics remained “relatively contained, especially considering the persistent solidity of the US labor market”.
This, adds the Moneyfarm CIO, “helps explain why inflation expectations for the next twelve months are more moderate today than those that prevailed a few months ago”.
The May employment report, we recall, highlighted the creation of 172,000 new jobs, well above analysts’ forecasts (+85 thousand units), while the unemployment rate remained stable at 4.3%.
What to expect from the Fed
Inflationary thermometer in hand, the basic scenario continues to be that of a Federal Reserve “willing to temporarily tolerate inflation above its target, to the extent that the recent increase is mainly attributable to a supply-side shock”, observes Richard Flax. This approach assumes that core inflation continues to “show a more contained dynamic compared to overall inflation”.
The story would change radically if prices excluding food and energy were to accelerate more markedly, in which case, concludes Flax, “the central bank could be forced to adopt a more restrictive monetary policy, with rate increases higher than those currently incorporated into market expectations”.
