Will the Fed “Pivot”?

Guest Post by Jim Rickards

The Federal Open Market Committee (FOMC) of the Federal Reserve System (the Fed) is meeting today and tomorrow for the purpose of discussing the economy and setting monetary policy going forward.

Today I’m going to preview the meeting, forecast Fed policy and assess what it means for the economy going forward.

On Wednesday, the Fed will leave its target rate for fed funds unchanged.

That decision will keep the federal funds target at 5.50% as set at the July 26, 2023, FOMC meeting. Over the course of 18 FOMC meetings beginning March 16, 2022, I’ve been correct in all of my forecasts including the policy rate pause that began last September. I’m confident I’ll be correct on Wednesday also.

In addition, I expect the Fed will do nothing to contradict prior indications that the rate hike cycle that began in March 2022 is over. In effect, the Fed has concluded that they’ve reached the terminal rate.

That’s the rate at which inflation is expected to come down on its own without further rate hikes. In the Fed’s view, the lagged effect of prior interest rate hikes will do the job of lowering inflation to the Fed’s target of 2.0%. No further action is required. It’s just a matter of time and patience.

Useless Dots

Tomorrow’s FOMC announcement will include an updated Statement of Economic Projections (SEP), known as the “dots.” These are forecasts of interest rates, unemployment and economic growth offered by members of the Board of Governors of the Fed, and regional Federal Reserve Bank presidents.

The dots have been wildly inaccurate in the past. Very few people take them seriously. While the dots are technically unimportant and usually wrong, they’ll be played up in the media. There will be a press conference by Fed Chair Jay Powell after the meeting.

The reason for the Fed sitting tight and not cutting rates (the infamous “pivot” that Wall Street has been wrong about for two years) is that the Fed is losing the battle against inflation.

When inflation (measured monthly by CPI on a year-over-year basis) dropped from 9.1% in June 2022 to 3.0% in June 2023, the Fed was ready to declare victory. The Fed’s goal was still 2.0% annualized inflation, but progress from 9.1% to 3.0% was so dramatic that 2.0% seemed well within reach. It was around that time (July 2023) that the Fed hit the pause button on further rate hikes.

Sticky Inflation

Since last July, the inflation news has been consistently bad for the Fed. Here’s the tale of the inflation tape using the Consumer Price Index on a year-over year basis:

(The CPI data for May 2024 will be released on June 12^th, the same day as the FOMC rate policy decision).

The Trend Is Not the Fed’s Friend

Several facts jump out immediately from this most recent 11-month time series. The first is that inflation is not going down. It’s higher today than it was 10 months ago. It’s bounced around a bit, hitting 3.7% last September and then moving down somewhat to 3.4% today.

Still, the best that can be said is that inflation is in a range with a central tendency of about 3.3%. It has been stuck in that range for almost one year and is not trending toward the Fed’s stated goal of 2.0%.

For the purpose of analyzing inflation, we use the headline CPI number. The reason is simple — that’s the number that everyday Americans actually pay at the grocery store and the gas pump, so it’s the best number for understanding behavioral responses, changes in expectations and political implications.

The eggheads at the Fed and Wall Street have devised “core CPI” (excluding food and energy), “super-core CPI” (excluding food, energy and housing), “core PCE” (a completely different index that the Fed prefers that also excludes food and energy), “trimmed mean CPI” (this measure disregards the highest and lowest figures as “outliers”) and so on.

That said, when the Fed claims to be data dependent, they rely on more than just the unemployment rate and CPI. Here’s a summary of recent data, some supporting a rate cut by the Fed and some suggesting the Fed should stand pat.

Data Supporting a Rate Cut by the Fed

• Atlanta Fed GDP Nowcast = 3.2% (down from recent estimate of 4.2% on May 14)

• The unemployment rate ticked up to 4.0% in the May employment report

• Oil prices have trended down from $86.90 to $78.85 over the last nine weeks

• Regular gas at the pump has trended down from $3.64/gal to $3.47/gal in the past month

• Consumer savings are largely depleted, and credit cards are maxed out

• Higher rates for credit cards are headwinds to consumption

• Higher rates for mortgages are a headwind to home purchases and consumer durables

• Inverted yield-curve continues to signal a coming recession

• Most job creation is in part-time jobs

• Labor force participation moved down from 62.7% to 62.5% in May employment report

• Jobs are going largely to illegal aliens.

Data Supporting No Rate Cut by the Fed

• ISM index in services was strong

• Job creation remains solid, up by 272,000 jobs in the May employment report.

• Unemployment rate remains low despite recent increases

• Inflation is sticky with a central tendency around 3.3% over 11 months.

This data is not given equal weighting by the Fed. The inflation rate is the dominant factor in a world where job growth remains strong. Given a mixed bag of data and continuing inflation above targets, the Fed will simply do nothing.

Waiting another month or two for more data is what this Fed does best. They’re in no hurry to do anything right now.

What We Don’t Know

We’ll learn more during Jay Powell’s press conference on the Fed’s future plans. At this point it’s clear the Fed will not cut rates tomorrow and is unlikely to cut rates at the July 31 meeting as well. Even if inflation cools off next month the Fed will not be prepared to pivot to rate cuts.

The Fed needs to see two or three months of solid progress before reaching a level of confidence that inflation is declining enough to permit rate cuts. Over the past 11 months, inflation has been increasing.

Based on this trend and the Fed’s methodology, rate cuts will not happen in June and probably not at the July meeting either.

Sorry, Wall Street, you’re going to have to wait a while longer for your beloved pivot.

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