We could be forgiven for nearly forgetting the Federal Open Market Committee begins its May two-day meeting this morning. With no chance of a rate move announcement, about the only curiosity is whether the statement on Wednesday could perhaps include a new tweak about heightened inflation concerns now that the PCE measures finally hit the 2% mark yesterday.
The short answer is not really.
*** The May meeting is likely to come and go with only minor changes in the statement language, namely in the descriptive first paragraph on the economy and in an update to the inflation sentences now that last year’s transitory inflation dip has washed out of the data. The Committee is likely to affirm it expects inflation to stabilize around the 2% symmetrical target. The key accommodative policy language will also remain in place. ***
*** We think the FOMC’s continued optimism on the economy, and for inflation’s eventual return to sustained mandate-consistent levels, points to another rate hike at the June meeting. But it would take several more months of stronger than expected momentum in the underlying inflation trend for the FOMC centrist majority to shift from the current gradual policy messaging to a quickened pace of rate hikes due to elevated inflation concerns. ***
ECI and PCE Data Points
We would caution in reading too much into the policy implications of the recent uptick in both Friday’s Employment Cost Index or yesterday’s PCE headline and core price prints. Both showed healthy gains with some pick-up in wages while last spring’s softness in inflation fell out of the data as expected to bring the core PCE back to 1.9%, a whisker shy of the 2% inflation target.
But after seven long years of missing the 2% inflation target and with wages only modestly rising — despite a headline unemployment rate well below its assumed NAIRU levels — the FOMC is not about to suddenly leap to the parapets to battle a sudden inflation risk.
Instead, in the coming weeks, we expect the large bloc of FOMC centrists, including Fed Chairman Jerome Powell, to stick to his “middle ground” messaging of caution before moving away from indicating a gradual pace of rate hikes while keeping an eye on deviations in the data from the base case forecast.
This Friday’s Non-Farm Payrolls print, for instance, will draw the usual Fed scrutiny to gauge the degree of slack still in the labor market and in particular, the trend in the labor participation rate.
The modest rise in the participation rate, against expectations of a long trending, demographic-driven decline, was one of the more pleasant surprises last year. More workers coming into the labor force slowed the decline in the headline unemployment rate that would have otherwise raised the alarm even among the more dovish-leaning FOMC members.
Without a slowing in the demand for labor, any evidence the good run in participation was coming to an end would elevate the Committee concerns that the labor market is just getting too tight for comfort, regardless of the differing views over the Phillips Curve.
Likewise, there will be a close eye on the various measures of inflation, for evidence of a building trend momentum, as well as any signs of inflation expectations becoming unanchored.
But any upside inflation surprises will need to play out for several months to confirm a sustained enough momentum to draw the Fed’s attention. That means that while June could see enough upside surprises in the data to draw a more hawkish statement or an upgrade in the rate dot projections, we still think it unlikely.
Instead, any upward, more hawkish shift in the policy stance is unlikely before mid-summer, possibly the July meeting, and we would not be surprised if it wasn’t until the September FOMC meeting that the Fed draws more definitive conclusions about the fiscal impact on growth and the demand for labor, and above all on the dynamics of an inflation process that has been so inertial for so long.