Following Q1 2023, Fed Officials remain on track for another rate hike on May 2nd-3rd, which will continue raising consumer and corporate borrowing rates. Most likely this will be a 25bps point increase. This may end up being the last rate hike in this cycle. The background on recent rate hike decisions relate to inflation readings like CPI, PPI, and PCE. The Fed’s goal is still to reach 2% inflation while keeping maximum employment.
The Consumer Price Index (CPI) ended 2022 (in December) at 6.5% year over year. When we found out that there was little change to CPI in January 2023 (CPI was 6.4%), the Fed had put another 50bps point rate hike back on the table for the meeting on March 21st-22nd. The February CPI announcement on March 14th revealed that CPI dropped to 6% ,which gave the Fed a reason to make a 25 bps hike instead.
The drop in the CPI and PPI, (CPI and PPI) has permitted the Fed to reduce the number of potential rate hikes in their forecast and the size of those rate hikes. This means they are now on track for a peak rate of 5.25-5.50%, which is lower than what has been previously estimated. The rate peak potentially could have been as high as 6% and this could still happen if inflation does not dissipate.
Some investors were and still are anticipating rate cuts sometime in 2023, despite CPI inflation averaging 5.8% YTD 2023. Maybe this is in part because the Producer’s Price Index (PPI) was 6.2% in December 2022 and dropped to 2.7% in March 2023, which shows a big drop.
The Personal Consumption Expenditures (PCE) was 4.6% in December 2022, and the rate in March 2023 is still 4.6%. This has always been the preferred inflationary data point for the Fed because it is weighted with the GDP. GDP changes vary based on where consumers are spending their money. The next Fed meeting is underway and we are anticipating another 25bps increase. PCE inflation has not dropped.
Rising borrowing rates and the tightening of the money supply has begun to effect consumers more and more (from Reuters, April 18th 2023) as people have been missing payments. This can hurt discretionary spending and has the potential to negatively affect earnings for those businesses. Earnings season has been in progress for Q1 2023 and continues to show some slowing. However, overall has been showing some positives.
Following this rate hike cycle, it is more probable that there will be a pause. The pause will allow these rate increases to flow through the economy and will give the Fed time to gauge the impact of these hikes and the balance sheet reductions.
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