By raising interest rates 75bp to 1.75% at its June monetary policy meeting, the Federal Reserve is telling us it is willing to risk recession for inflation. Not only did the central bank raise interest rates by the largest amount since 1994, according to Fed Chairman Jerome Powell, rates could increase 50bp or 75bp at the next meeting. Based on its dot plot, 50bp rate hikes are expected at every meeting for the rest of the year. Having failed to control inflation with prior moves, it is doing whatever it takes to reverse the rise in prices and bring inflation down. Powell justified today’s large hike with higher real GDP growth this quarter, strong consumption, tight labor market and elevated wage growth.
Unfortunately, according to its own economic projections, the Fed expects growth to be weaker, the unemployment rate and inflation to be higher – which is a recipe for recession. In fact, its forecast for rate cuts in 2024 suggests it also expects growth to weaken significantly. Today’s retail sales report showed spending turned negative for the first time this year. Retail sales dropped 0.3% in May, which was a big surprise, with core spending growth slowing to 0.1% from downwardly revised 0.8%. Americans are dipping into their savings to cope with rising prices, according to the recent drop in the personal savings rate, which fell to its lowest level since 2008. Investors should brace for significant deterioration in data in the coming months. Still, stocks rallied because investors are optimistic about the Fed’s commitment to fighting inflation, and it finally sees a way out of rising prices. Bond yields plunged, driving the U.S. dollar lower.
Top 10 Takeaways from June 2022 FOMC
1. Fed Hikes 75bp, biggest move since 1994
2. Next Fed meeting could be another 50bp or 75bp hike
3. One dissent for smaller 50bp hike (George)
4. Interest rate forecast raised to 3.4% from 1.9% = Rate hikes at every meeting
5. Inflation forecast raised to 5.2% for 2022 from 3.4%
6. Growth forecast lowered to 1.7% for 2022 from 2.8%
7. Unemployment rate forecast raised to 3.7% for 2022 from 3.5%
8. Projections show rate cuts begin in 2024
9. Fed doesn’t know how restrictive policy needs to be
10. Powell expects soft landing because spending and labor market are strong
The FOMC meeting is behind us, but now is not the time to be complacent. There are still three major central bank announcements this week – from the Bank of England, Swiss National Bank and the Bank of Japan. While no changes are expected from the SNB and BoJ, the BoE is widely expected to join the Fed in raising interest rates. Inflation is near double digits in the U.K., but unlike the Fed, the BoE does not have the flexibility to raise interest rates by 75bp. The economy is shrinking, according to the latest GDP report that showed growth falling at its fastest pace in more than a year. This unexpected contraction underscores the challenges faced by the Bank of England, which expects rising prices to take a bigger bite out of growth in the months ahead. The U.K. jobs report reinforced the economy’s weakness, with wage growth slowing and the unemployment rate rising. Although the BoE will reaffirm a hawkish bias after tightening on Thursday, the smaller move should limit demand for sterling.
For the Swiss National Bank, inflation is also its biggest problem. CPI rates are running at their hottest levels since 2008. However, just this morning it lowered its economic projections in the face of ongoing geopolitical uncertainty and higher food and energy costs. The worry is that growth could weaken further if Russian gas supplies remain halted. This downgrade is a precursor to its decision to leave interest rates unchanged. With that said, the SNB is still under pressure to join its peers in normalizing monetary policy.
The Japanese yen may be trading at its lowest level in decades against the U.S. dollar, but the Bank of Japan is committed to keeping interest rates from rising. Over the past few weeks, its 0.25% yield cap has been challenged. It has responded with aggressive bond buying. The question this week is whether the BoJ feels it necessary to adjust its yield caps. The weak yen is a big problem for Japan’s economy, especially in a high-inflation environment because it pushes the cost of imported fuel and raw materials even higher. Although BoJ officials may lament about the currency’s movement, intervention is the Ministry of Finance’s decision.
Aside from these rate decisions, New Zealand first quarter GDP and Australia’s jobs report will also be released this evening. GDP growth in NZ should be stronger, but Australian job growth is expected to weaken. With that said, AUD and NZD, which soared on the back of U.S. dollar weakness post-FOMC, will continue to trade on the market’s appetite for U.S. dollars.