Fed Speak Ahead of May FOMC; GDP Poised to Impress

Ahead of next week’s FOMC meeting, a number of Fed officials took to the stage last week, emphasizing both the Fed’s focus on inflation as well as a need for patience when it comes to banking-sector volatility.

?

According to St. Louis Fed President James Bullard, for example, the Fed has significantly more work to do in terms of taming inflation. Speaking in an interview with Reuters, Bullard said that despite recent market turmoil, he has lifted his expectations for policy from two to three more rate hikes.

?

While arguably one of the more hawkish members of the Committee, Bullard has been consistent in his focus on inflation and the Committee’s need to slay the inflation dragon this first time around. Should the Committee fail in its resolve, policy makers may need to re-engage in a second round of policy firming later on, potentially resulting in even more painful implications for the economy as seen in the 1980s.

?

Bullard also highlighted the growing disconnect between the Fed and the market’s expectations for policy. The market continues to anticipate no further Fed action beyond May with a series of rate cuts priced in beginning in July. Of course, this is not the first time the market and the Fed have disagreed about the Committee’s next move or the longer-run trajectory of rates. In each earlier occurrence of opposition, however, the market has been reminded of the old adage?“don’t fight the Fed.”?While this time, of course, could be different, we do suspect investors may once again be reminded that the Fed’s focus is on its dual mandate of full employment and stable prices, not comforting markets during times of volatility. While the Fed is certainly aware of the ongoing turmoil and sensitivity in market conditions, it will not supersede the Fed’s resolve to reinstate price stability.

?

That being said, even with somewhat of a reversal in rates, up 22bps since a recent low of 3.31% on April 6, there is increasingly less conviction for another round backup, or at least something similar to what played out in October of last year, or the more recent sizable rally in long-term rates heading into the collapse of SVB, given the Fed’s lack of solid rhetoric. While the Fed is likely to move forward with a rate hike in May and beyond, the lack of strong language to accompany said policy adjustments is likely to result in?some?– but seemingly a lackluster amount of – upward pressure on longer rates, but more importantly, leave ample uncertainty in terms of the direction of policy, with wild swings in the 10-year likely to persist.?

?

Despite?a lack of improvement in inflation and the return of relative?“calm”?to financial markets, at least some Fed officials, meanwhile, have been more poignant in their expectations, signaling a potential pause in policy after another 25bp hike in May.?Philadelphia Fed President Patrick Harker, for example, said the Fed is likely?“close”?to where it should be in terms of policy.

?

Similarly, Atlanta Fed President Raphael Bostic, said he is in favor of a?“one and done scenario”?referring to a final rate hike in May followed by no further policy action.

?

Meanwhile, Cleveland Fed President Loretta Mester, also a non-voting member, was less convinced the Fed would be able to move to the sideline quite yet. Although, while maintaining expectations for?rates to move well above 5%, at the same time, she also called for?“prudence”?amid tighter credit conditions.?

?

Also speaking last week, New York Fed President John Williams and Chicago Fed President Austan Goolsbee highlighted a growing – not necessarily concern – but acknowledgement of the recent banking volatility and the likely result of tighter credit conditions. While convinced the banking sector has largely stabilized, Williams said there will likely be some tightening in credit conditions, although it is still too early to assess the magnitude or duration, suggesting at least at this point, the Fed needs to continue forward with additional rate hikes.?

?

Goolsbee also suggested the Fed is closely watching bank credit conditions. However, he reiterated the notion that should such an organic change in credit conditions do some to the Fed’s work in terms of taming inflation, the Committee may not need to raise rates quite as high as previously expected if total policy firming reflects further rate hikes and an organic adjustment in credit conditions.

?

According to the H.4.1 data reported by the Fed,?emergency borrowings from the Fed rose for the first time in five weeks, jumping from $139.5b to $143.9b, still well below, however, the initial rise of $164.8b following the SVB collapse. Thus, while?“stresses”?still remain, emergency borrowing had abated and the most recent data suggests deposit outflows from smaller banks has slowed. Meanwhile, inflation remains elevated with key measures such as core services excluding shelter more than nearly three times the Fed’s preferred target of 2%.?

?

This week, with Fed members entering their blackout period, the focus is on the economic calendar. This morning, the Chicago Fed National Activity Index remained at a reading of -0.19 in March for the second consecutive month. According to the median estimate on?Bloomberg, the index was expected to decline to -0.20.?The Chicago Fed Index draws on 85 economic indicators; a reading below zero indicates below-trend growth in the national economy and a sign of easing pressures on future inflation. In March, 43 of the 85 monthly individual indicators made positive contributions, while 42 made negative contributions.

?

Also this morning, the Dallas Fed Manufacturing Index unexpectedly declined further from -15.7 to -23.4 in April. According to the median estimate on?Bloomberg, the index was expected to rise to a reading of -12.0 in April.

?

Tomorrow, the Richmond Fed Manufacturing Activity Index will be released, and on Thursday, the Kansas City Fed Index will be released followed by the Chicago PMI on Friday.

?

Along with manufacturing, a number of housing market reports will be released this week as well, with the FHFA Home Price Index, the S&P 20-City and National Home Price Index and March new home sales all released tomorrow. The weekly mortgage applications data will be released on Wednesday, and the March pending home sales report will be released on Thursday.

?

Additionally on Tuesday, we will have an updated look at the April Conference Board’s Consumer Confidence reading as well as the University of Michigan Consumer Sentiment Index, which will be released on Friday.?

?

The key reports of the week, however, begin on Wednesday with a preliminary look at March durable orders. Last month, durable goods orders unexpectedly fell 1.0% in February, following a 5.0% drop the month prior. Year-over-year, however, headline orders rose 2.3% in February, down from the 2.5% annual increase the month prior.

?

On Thursday, we will have the first read on Q1 GDP. At the end of last year, GDP was unexpectedly revised lower one-tenth of a percentage point to a 2.6% increase on an annualized basis in the final Q4 report. The resilience of the consumer at the start of the year will expectedly keep growth in positive territory across the first three months, likely surpassing many earlier forecasts. Nevertheless, growth is expected to post a markedly reduced pace relative to Q4 with downside risks to topline activity going forward as consumer activity presumably continues to slow with Fed tightening threatening to push the economy into recession.?

?

Finally, on Friday, the latest income and consumption figures will be released, along with an updated read on the PCE. This month, the PCE is expected to rise 0.1% in March and 4.1% over the past 12 months. The core PCE, meanwhile, is expected to increase 0.3% at the end of Q1 and 4.5% year-over-year, down only a tenth of a percentage point from the month prior.

?

?-Lindsey Piegza, Ph.D., Chief Economist?