Pricing for a Pause
June 15, 2023
We are pricing for a pause although the market-based probability of a July rate hike rises to 67% after yesterday’s revised dot plot implied two more hikes. The dot plot was more hawkish than expected, but the statement and Powell’s press conference sent a more dovish message. The meeting is being characterized as a ‘hawkish skip’ which triggered an immediate spike in bond yields and pullback in equity markets. Those conditions quickly reversed once investors read the full policy statement and listened to Powell press conference, which included the most dovish takeaways of this hiking cycle. As we noted yesterday, rates are considered to be sufficiently restrictive once they match or exceed core CPI on a YoY basis. The Fed funds rate is 5.25%, and May core CPI came in at 5.2%. Skipping a rate hike yesterday also acknowledges that monetary tightening operates with a lag, especially when using official government statistics like CPI and PCE. Market based inflation measures like inflation swaps have been more accurate than the Fed with the current 1-year swap sitting at 2.35%. The June headline CPI number that precedes the July Fed meeting should fall to ~3.2% on base effects alone. April headline CPI came in at 4.9%, and 170bp of disinflation in 60 days should be enough to convince the Fed to skip a July hike as well. Markets would likely perceive a second consecutive skip as the end of the tightening cycle, resulting in lower bond yields and higher stock prices.
Elsewhere, the ECB hiked rates as expected with tomorrow’s BOJ meeting being the last central bank decision for the week. China cut its MLF rate today and reports suggest Beijing will adopt additional stimulus steps in the weeks ahead, including cutting its Loan Prime Rate next week.