The economic expansion has advanced from the initial recovery, and the focus is now on metrics the Federal Reserve is looking at to gauge the health of the economy. Since the Fed’s dual mandate is to keep prices stable and maximize employment, we will focus on labor and inflation metrics, keeping in mind the broader economic impact as well. We created a Fed Monitor to track some of the data points that will impact the Fed’s decisions to tighten financial conditions. Additionally, we try to quantify the data and information outside of the dashboard to determine if the Fed is being more dovish than the data, and likely to be more aggressive in the future, or if they are being hawkish relative to the data, and likely to be more conservative in the future.
A new chapter for the Federal Reserve (Fed) begins with Kevin Warsh replacing Jerome Powell as Fed Chair. Despite the change in leadership, we do not expect an immediate shift in rate policy. Warsh will oversee the same group of voting members, including Powell, who will remain on the Board of Governors. As a result, the Fed is likely to remain on hold for the foreseeable future. That said, the Fed’s rate cutting bias may shift toward a more neutral stance as the Fed pivots from labor market concerns toward renewed inflation concerns. Futures markets are now pricing in higher odds of a rate hike before the year is over than a rate cut. While an extended pause is the most likely outcome, rate hikes are back on the table.
On the economic front, labor market conditions are improving while inflation pressures are building. The U.S. economy added 115,000 jobs in April, bringing the year-to-date monthly average to 76,000. The unemployment rate is holding steady at 4.3% and private sector job growth outside of health care is improving. Furthermore, jobless claims remain at low levels. At the same time, inflationary pressures are rising. Higher energy costs pushed headline CPI inflation to a 35-month high of 3.8% year-over-year (Y/Y) in April. Core CPI, which excludes food and energy, remains lower at 2.8% Y/Y. However, the Fed’s preferred inflation gauge, the core PCE price index, is up 3.2% Y/Y and advanced at a 4.3% annualized pace in the first quarter. Inflation is drifting farther above the Fed’s long-term 2.0% target.
With inflation concerns reemerging and the labor market stabilizing, the Fed no longer appears to have a rate cut bias. Until activity in the Strait of Hormuz normalizes, energy-driven inflation pressures could persist. For now, we expect an extended Fed rate pause and are moving the Fed-O-Meter to the middle to reflect the Fed’s likely shift to a neutral stance.
