MANHATTAN (CN) — Wall Street celebrated the decision by the Federal Reserve to pause its march of interest rate hikes, despite hawkish comments by the central bank that suggest further rate increases may come later this year.
After 10 consecutive rate hikes, the central bank decided during this week’s meeting to keep interest rates put at 5% to 5.25%. The Fed kept its hawkish stance, with its accompanying statement noting additional policy firming “may be appropriate.”
The news helped an already bullish market, and by the closing bell on Friday the Dow Jones Industrial Average had gained 425 points since the week prior, while the S&P 500 increased 111 points, and the Nasdaq added 430 points.
“There is a path to getting inflation back down to 2% without having to see the kind of sharp downturn and large losses of employment that we’ve seen in so many past instances,” Fed Chair Jerome Powell told reporters after the meeting, adding that the Fed will “do whatever it takes” to get inflation down. “We understand that allowing inflation to get entrenched into the U.S. economy is the thing that we cannot, cannot allow to happen.”
The Fed seems justified in its skip — for now — as inflation has continued to cool. On Tuesday, the U.S. Bureau of Labor Statistics reported consumer prices rose by just 0.1% last month after a 0.4% increase in April. Headline CPI inflation is now at a two-year low of 4%, though core inflation is at 5.3%.
Shelter prices were the largest contributor in May, adding 0.6% to the bottom line and up 8% in total since May of 2022. The food index also increased by 0.2%, the same amount as in the prior two months. Energy prices were the largest drop, falling 3.6% last month, with fuel oil seeing a huge drop of 7.7%. In total, fuel oil prices have fallen by 37% since this time last year.
“The CPI report is everything the Fed needs to pause,” said Jamie Cox, managing partner at Harris Financial Group, noting every category has seen deflation or disinflation and that even the sticky parts of the data like rent are likely at a inflection point. “If this trajectory holds in June, the need for further tightening is behind us,” Cox said.
Some still say a rate hike is on the table for July, though rate cuts could also be in the works for later this year if unemployment continues to inch higher and inflation drops to 3%.
“The outlook for inflation and interest rates in the second half of the year largely depends on how much the economy cools from here,” said Bill Adams, chief economist at Comerica Bank. He noted, though, the economic growth has been surprisingly resilient, which could force the Fed to keep rates higher than it originally intended.
According to the dot plot — the anonymous positions of members of the Federal Open Markets Committee — the Fed is likely to hike rates by an additional 50 basis points spread out over two more meetings. Most of the members of the FOMC believe the federal funds rate will come down sometime in 2024 and drop to below 4% by 2025.
Producer prices, also released by the BLS this week, helped strengthen the Fed’s hand, with the index showing a 0.3% decline in prices last month, well below the 0.1% decline many had forecast. This follows the slight 0.1% increase in April, and the producer price index is now at 2.8% for the year.
The PPI has fallen before, last time in March by 0.4%, so this doesn’t necessarily indicate a trend. But producer prices now are 1.1% higher in the last year, which does indicate a trend since annualized final demand has dropped 11 straight months. Except for flatlines in February and last September, core final demand also has continued to fall during that same period.
Some worry that inflation may prove to be harder to quell in the long run. Peter Boockvar, chief investment officer at Bleakley Financial Group, said that “there is one thing to see inflation fall back but there will be another thing to see it stay down.”
If inflation remains high and the Fed does not continue to raise rates, it could also leave the U.S. economy in a “no-man’s land where inflation is above target, monetary policy is tight, and employers hoard labor,” said Chris Zaccarelli, chief investment officer at the Independent Advisor Alliance. “As long as this dynamic persists, we won’t have a recession, but ultimately something has to give.”
Zaccarelli also pointed to retail sales numbers released this week that showed a 0.3% increase in May, stronger than many expected or even hoped for. “The likely path of the economy is to muddle along until spending slows or unemployment rises and the stock market can continue to rally until that time as the current trends reverse,” he said. “Monetary policy famously acts with long and variable lags, and we are all living that maxim.”
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