Fed Holds on Rate Hike for June

As many have predicted for weeks, the Federal Reserve’s Federal Open Market Committee decided to pause rate increases for the first time in 15 months. What that will mean going forward is unclear, but CRE is still seeing an additional rate shock because the Fed isn’t the only force in play.

A Fed release stated that the “U.S. banking system is sound and resilient” and point to tighter consumer and business credit conditions that “are likely to weigh on economic activity, hiring, and inflation.”

Some observers have been concerned that tight connection between the progression of inflation and the actions the Fed takes are not enough in sync.

“Monetary policy is at a critical juncture,” wrote Oxford Economics. “After decades of low and stable inflation, the seismic supply adverse shocks and robust demand of recent years have jolted inflation expectations. Now, the largest and likely to be the most persistent inflation overshoot we’ve seen in the inflation-targeting era is fueling debate about whether inflation targeting is fit for purpose.”

The Fed has to come to grips with “more common adverse supply shocks,” the firm wrote. Climate change, for example, is resulting in more frequent and severe weather events, like the widespread wildfires in Canada that have pushed lumber prices up 10.3% since the end of May. Monetary controls have little effect on supply-induced inflation.

Also, the economy has not slowed the way the Fed had assumed it would. The CPI reading yesterday showed seasonally adjusted 0.1% growth between April and May, making a non-adjusted 4% year-over-year increase, the lowest number since March 2021.

But core inflation was up 0.4% on a month-over-month basis, showing an economy that’s still running much hotter than policymakers would like. The largest contributor? Shelter costs that have had enough time to start showing moderation, given the time gap between changes and when their effects are measured. All this is far above the 2% inflation rate that the Fed has kept as its goal.

“Overall, the data set should provide cover for the Fed to take a pause at tomorrow’s meeting, but the sixth consecutive month of increases above 0.4% in core inflation questions the need for more rate hikes and leaves the option open for another hike at the July meeting,” as Allianz Investment Management Senior Investment Strategist wrote yesterday.

And yet, James Thorne, chief market strategist for Wellington-Altus started the morning by tweeting, “Hawkish communication as always. Expect dot plots to show more hikes. Ignore.”

The Fed’s take: “In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals.”

In other words, no one knows the future with certainty because the Fed doesn’t.

In terms of practicality, though, CRE still gets a rate hike from the delay in rectifying the debt ceiling crisis. Yields on short-term Treasury bills have a significant effect on lending rates that must show greater risk-adjusted profitability than what can be gained by safely parking money with the government. A 26-week Treasury that issued on March 30, 2023, went on initial sale for an annual percentage return of 4.83%. But a 26-week Treasury bill that will issue June 15 auctioned with an investment rate of 5.38%, a 55-basis point jump.