The June FOMC meeting was one that launched a billion flatteners. The combination of Fed policymakers leaving inflation forecasts unchanged, but predicting more rate hikes in 2023 ran smack into 12 months of verbal assurances that rate hikes would be less sensitive to inflation in the coming cycle.
- The Federal Reserve held steady its target for overnight rates to a range of 0 – 0.25%, as they have for more than a year
- There were no material policy changes, and we continue to anticipate zero interest rates through 2022, possibly longer
- Bond buying to continue at the current $120 billion/month pace ($80 billion USTs/$40 billion MBS) with no sign of taper in the text
- The Fed set up standing repo facilities, essentially making permanent a feature of the post-pandemic financing landscape
In other words, official projections are calling into question Flexible Average Inflation Targeting, FAIT. In response, the yield curve violently flattened, with front-end yields rising slightly and long-end yields falling to their lowest since February. We all knew the Fed would not hike rates or reduce bond buys this meeting—and they did not. The real question at the July FOMC meeting is not about taper timing (as headlines would have you believe), but rather about how aggressively Powell should defend FAIT in his comments.
Economic data since the Fed last met was generally firmer, though directionally in line with recent trends. The June employment report bested expectations with +850K in payroll gains, the best showing since the post-lockdown bounce last August. Retail sales have firmed up even further and are running at a +11% yearly change. Perhaps most importantly, however, the monthly inflation numbers remained very perky, with June’s core CPI rising +0.9%, well above expected. A good piece of the increased monthly inflation numbers represent the triumph of rising demand for goods and services against a backdrop of constrained supply, but in particular, shelter expenditures seem to have some upside risk. Given that housing costs represent about a third of various inflation measures, even a 3% trend inflation rate in housing means that core inflation will exceed the 2% mark in 2022, absent an aggregate supply response that holds prices of other goods and services down. That latter hypothetical is possible given how unpredictable inflation dynamics are right now, though it does not intuitively seem likely.