The Federal Reserve... Reserves the Right to Remain Hawkish

Chief Economist Eugenio J. Alemán discusses current economic conditions.

If there was a message the Federal Reserve (Fed) wanted to make clear after the end of the Federal Open Market Committee (FOMC) meeting on May 3, it was that it reserves the right to remain hawkish. That is, even though we think that May’s federal funds rate increase was the last one of this cycle and that the Fed is going to pause, the inflation environment remains skittish, to say the least. At the same time, we are expecting a rebound in monthly inflation once the April Consumer Price Index report (CPI) is released next week which could keep the year-over-year rate almost unchanged from the previous month’s year-over- year rate.

Furthermore, Thursday’s release of the Productivity and Unit Labor Cost report during the first quarter of the year added to last week’s Employment Cost Index report and reminded us, and Fed officials, of the still difficult road ahead to continue to bring down inflation. Last week we saw that the Employment Cost Index increased by about 1.2% during the first quarter of the year, quarter-over-quarter, and by 4.7% at a quarterly annualized rate. This week’s Productivity and Unit Labor Cost report showed that productivity declined by 2.7% at an annualized rate during the first quarter, pushing unit labor cost to an outsized rate of 6.3% during the quarter after it had weakened considerably during the previous quarters. Thus, at this rate of growth, labor costs remain one of the biggest threats to the ongoing disinflationary process that started in June of 2022.

Eugenio J. Alemán, PhD,
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Fed Chair Jerome Powell, during his press conference, was clear that a pause in rate increases had not been decided during the meeting of the FOMC and that the institution was going to be driven by incoming data, which is no different than what is always said. However, this type of response is, typically, not liked by markets as it continues to generate uncertainty on the path forward for interest rates. Before the meeting, markets were already predicting an incoming pivot by the Fed but if there is a possibility for the Fed to continue to raise interest rates going forward, this pivot is going to be delayed once again and we know that markets don’t like uncertainty. Markets look for certainty on the end to this tightening cycle, but the Fed has remained unmoved by their insistence on more clarity on a terminal rate.