It’s sunshine season but an uneasy equilibrium lies ahead
Key points
- The FOMC kept monetary policy steady, needing better inflation data to justify lowering rates.
- Relatively benign data with respect to Eurozone inflation have cemented expectations for a June rate cut.
- The yen remains under pressure, following a more dovish-than-expected BoJ meeting last week.
- As we look forward, there is a bit of a sense of an uneasy equilibrium.
Government bond yields declined slightly over the past week, led by gains at the front end of the yield curve. The May FOMC gave little catalyst to price action in fixed income markets, with the FOMC reiterating that monetary policy remains on hold.
Powell continues to communicate a desire to lower rates but needs better inflation data to substantiate this. This could become more apparent in future months but coming on the back of recent disappointments in CPI, ECI and PCE core readings, it will likely take a few months of better numbers before this is the case.
Meanwhile, although further rate hikes cannot be ruled out, Powell’s messaging gives the clear impression that the bar to moving in that direction is relatively high. Were core inflation to head back up towards 4.5%, then this could challenge the Fed’s thinking. Yet with November’s election looming, don’t be surprised that some ongoing disappointment with inflation can be tolerated, on the notion that elevated interest rates just need more time to have their desired effect.
This notwithstanding, we are inclined to think that inflation data is much more important in determining the direction of policy and financial markets than activity data is, for the time being. We generally see economic activity moving ahead on a healthy trajectory, supported by a labour market which continues to look in good shape.