Fed Points to a Pause in May After Hikes Have Time to Sink In

Policymakers are widely expected to raise rates by a quarter percentage point at the conclusion of a two-day gathering on Wednesday. This would slow the rate of increase from December, when rates were raised by 50 basis points, to a range of 4.5% to 4.75%. This would be the fifth straight increase of 75 basis points. In December, Fed officials projected that they would pause when rates moved above 5%. However, Wall Street traders believe that the Fed will actually halt slightly below that level.‍

January 31, 2023

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This is based on a timeline sketched out by one of the Federal Reserve's most closely watched hawks, Governor Christopher Waller. Waller was an early advocate of the Fed's front-loading rate-hike strategy last year.

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Policymakers are widely expected to raise rates by a quarter percentage point at the conclusion of a two-day gathering on Wednesday. This would slow the rate of increase from December, when rates were raised by 50 basis points, to a range of 4.5% to 4.75%. This would be the fifth straight increase of 75 basis points.
In December, Fed officials projected that they would pause when rates moved above 5%. However, Wall Street traders believe that the Fed will actually halt slightly below that level.

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US central bankers have said that the decline in inflation seen in October, November and December is welcome news, but they still need to see more data before making any decisions.

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Waller stated on January 20th that the argument is simply whether it is better to pause after three months or six months of data collection. From a risk management perspective, Waller believes that it is necessary to have six months of data, rather than just three. The core personal consumption expenditures index rose 2.2% in the three months through December on an annualized basis, and 3.7% over the past six months, a slowdown from its 4.4% pace in the last 12 months, according to a report released Friday.

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Vice Chair Lael Brainard spoke the day before Waller and pointed to declines in three- and six-month measures of inflation.
If these trends continue for three more months, it could give policymakers enough confidence to pause at their May 2-3 meeting. This is when they will have data for January, February and March.

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Brett Ryan, a senior US economist at Deutsche Bank, said that the messaging from the Fed has shifted from urging people to get moving quickly and hunker down to being more focused on the end point. He said that the Fed now has to feel its way around where the end point is. Officials have stressed the need to see a few more months of similar soft readings on inflation to convince them that the gauges are on a meaningful decline back to their 2% target. This is in light of how they got head-faked in 2021 when prices cooled and then heated back up again.

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Waller noted that some encouraging trends in wage numbers have emerged over the past few months, with a deceleration in inflationary pressures. However, he cautioned that some monthly measures of inflation remain largely unchanged from where they were at the start of the year. He was one of the officials who said explicitly that they were okay with slowing the rate to 25 basis points this week while continuing to tighten. The change in tone and appearance of consensus about slowing the pace of rate increases was eye-catching. It seemed that everyone was in agreement that rates should be slowed down as we approached the end of the year.

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"Even though it was still early December, the markets were trying to be very grumpy and resistant to any kind of optimism," said Julia Coronado, president of MacroPolicy Perspectives in Austin, Texas. “It's interesting that, going into this meeting, members who are more inclined to support stimulus measures and those who are not are both comfortable with a 25 basis point cut,” she said.

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Policymakers can transition to a risk-management mode by shifting to a slower pace of increases and keeping pressure on demand while reducing the risk of overtightening. This approach helps to manage risks while still putting pressure on demand. Lorie Logan, president of the Dallas Fed, said earlier this month that she believes we need a strategy that is both flexible and robust. She said we need to continually and carefully assess what the incoming data imply about the economic outlook and adjust course accordingly.

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Federal Reserve officials are considering pausing interest rate hikes at their March meeting if more evidence of cooling inflation emerges. This would be a shift in policy from the previous stance of gradual rate hikes.