Market Views from the Global Fixed Income, Currency & Commodities (GFICC) group
The Federal Open Market Committee (FOMC) voted to keep the federal funds rate target range unchanged at 4.25% – 4.50%.
Changes to the FOMC Statement:
- The economic assessment was unchanged in its characterization of the economy expanding at a solid pace, but the Federal Reserve (Fed) acknowledged that a surge in imports during the first quarter (Q1) distorted real GDP.
- The Fed noted that uncertainty has risen further and commented that the risks for higher unemployment and higher inflation have risen.
Key Quotes from Chair’s Press Conference:
- Current and expected policy stance:
- “Our monetary policy actions are guided by our dual mandate to promote maximum employment and stable prices for the American people. At today's meeting, the committee decided to maintain the target range for the federal funds rate at four and a quarter to four and a half percent and to continue reducing the size of the balance sheet. The new administration is in the process of implementing substantial policy changes in four distinct areas. Trade, immigration, fiscal policy and regulation. The tariff increases announced so far has been significantly larger than anticipated. All of these policies are still evolving however, and their effects on the economy remain highly uncertain. As economic conditions evolve, we will continue to determine the appropriate stance of monetary policy based on the incoming data, the outlook and the balance of risks.”
- “We may find ourselves in the challenging scenario in which our dual mandate goals are in tension. If that were to occur, we would consider how far the economy is from each goal and the potentially different timelines over which those respective gaps would be anticipated to close. For the time being, we are well positioned to wait for greater clarity before considering any adjustments to our policy stance.”
- “Again, what I would say is that we think our policy rate is in a good place. We think it leaves us well positioned to respond in a timely way to potential developments. That's where we are. And that depending on the way things play out, that could include rate cuts. You know, it can include us holding where we are. We just are going to need to see how things play out before we make those decisions.”
- Inflation, Inflation Expectations, and the Impact from Tariffs:
- “If the large increases in tariffs that have been announced are sustained, they are likely to generate a rise in inflation, a slowdown in economic growth, and an increase in unemployment. The effects on inflation could be short lived reflecting a one-time shift in the price level. It is also possible that the inflationary effects could instead be more persistent. Avoiding that outcome will depend on the size of the tariffs effects, on how long it takes for them to pass fully into prices and ultimately on keeping longer-term inflation expectations well anchored. Our obligation is to keep longer-term expectations in line and a one-time increase in the price level from becoming an ongoing inflation problem. As we act to meet that obligation we will balance our maximum employment and price stability mandates. Keeping that in mind, without price stability we could not achieve the long periods of stronger labor market conditions that benefit all Americans.”
- “I think the underlying inflation picture is good. It's what you see, which is inflation now running a bit above 2% and we have had basically decent readings in housing services and non-housing services which is a big part of it. That part is moving along well.”
- Fiscal Policy, Growth Risks and Uncertainty:
- “Uncertainty about the path of the economy is extremely elevated and that the downside risks have increased. The risk is, as we pointed out in our statement, the risks of higher unemployment and higher inflation have risen. But they haven't materialized yet. They really haven't. They are really not in the data yet. So, and that tells me more than intuition because I think it's obvious, actually, that the right thing for us to do is… we are in a good place, our policy is in a very good place, and the right thing to do is await further clarity”.
- “We don't give congress fiscal advice. They are going to do what they do -- we take what they do as a given and we put it in our models and in our assessment of the economy. So, I wouldn't want to speculate on that. I think we do know that the debt is on unsustainable level, on an unsustainable path not an unsustainable level but an unsustainable path and it's on congress to figure out how to get us back on a sustainable path and, you know, it's not up to us to give them advice.”
Our View:
- In the absence of clear labor market weakness, the Fed is likely to remain on hold to assess the path for inflation. Since the FOMC last met on March 19th, the level of uncertainty around the backdrop for global trade has risen as the effective tariff rate proposed and implemented by the Trump administration significantly exceeded expectations. The resulting decline in consumer and business sentiment has not yet translated into a material deterioration in monthly payrolls growth. At the same time, short-term inflation expectations have risen. We expect the Fed to look through tariff related inflation so long as it is perceived to be a one-time price level reset that does not result in unanchored inflation expectations, but this will take time to determine. The Fed will monitor both survey-based and market-based measures of inflation expectations and take a holistic approach with greater emphasis on market-based inflation expectations beyond the next 12 months which we believe signal that expectations are still well anchored.
- Despite downside risks to the U.S. economy having increased notably, we retain our base case of sub-trend growth. The extent to which the economy avoids recession is dependent on the length of time that the effective tariff rate and policy uncertainty remain elevated. The U.S. economy has proven resilient so far in this cycle and corporate balance sheet fundamentals suggest businesses have a strong starting point to manage higher costs. Nevertheless, we do expect job growth and economic activity to moderate and the Fed to respond with further rate cuts later this year. If this mix of high tariff rates and low confidence persists into the summer, we expect economic outcomes to worsen materially in the coming months and the risk of recession to rise.
- We maintain our expectations of the trading range for the ten-year U.S. Treasury (UST) yield to be 3.75% - 4.50%. A central bank on hold but with an easing bias, along with a balanced labor market and continued moderation in wages, should limit the magnitude in which yields can rise even if the trade backdrop becomes less uncertain. The bar for the Fed to consider shifting away from an easing bias towards a hiking one remains very high. If the labor market does start to weaken materially, we would expect the ten-year U.S. Treasury to shift into a new lower trading range for yields and the Fed to consider cutting rates in larger increments to reach a more neutral level of the Fed Funds rate faster. A larger than expected fiscal stimulus package passed by congress would present an upside risk to our forecasted trading range.