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Thought of the day

The Federal Reserve will announce its latest monetary policy decision today, 14 June. Our expectation is that the Fed will leave rates unchanged, in line with market pricing.

But, we believe US rate setters face an unusually close decision at the FOMC meeting. Fed Chair Jerome Powell may have difficulty achieving a consensus that decision makers can support. And market outcomes may be particularly dependent on a number of other factors beyond the rate decision itself.

Here are three things we’re watching for the meeting:

The Fed’s statement. The messaging and tone of the FOMC statement will give greater detail on how Committee members assess mixed economic data for the US. Our sense is the statement will indicate a “hawkish” pause from the Fed. Recent economic data mean it would not be difficult for the Fed to justify a rate hike at this meeting, had they not already indicated a desire to assess the lagged and variable effects of 500 basis points of cumulative rate increases.

After all, inflation continues to run well above its 2% target. While CPI data for May showed headline inflation slowing to 4% year-over-year (down from a peak of 9.1% last June), core CPI has risen by 0.4% month-over-month for the last six months, a reminder that the underlying inflation trend is still too strong.

It will be important to look for any guidance on how the Fed judges price pressures across volatile goods and housing components, against service sector and wage settlement developments. In this context, the US labor market still looks very tight. Nonfarm payrolls rose by a stronger-than-expected 339,000 in May, while upwardly revised data for the two prior months lifted the three-month average to 283,000 from an initial 222,000. The latest reading on job openings also showed a surprise increase back above 10 million, and the Atlanta Fed’s wage tracker showed an increase of 6% year-over-year in May, inconsistent with sustained 2% inflation.

The chair’s press conference. The main reason for thinking that the Fed won’t hike this time is the public statements from the Fed’s leadership, including Chair Powell. It will therefore be important for investors to analyze his commentary to judge the balance between dovish and hawkish policymakers.

We expect policymakers to send a clear message to markets that at least one more rate hike is likely at a later meeting. How and why this happens matters to markets, given that consensus and Fed staff forecasts expect mild recession conditions for the US in the second half of the year with additional risks from banks tightening their lending standards further.

The Statement of Economic Projections and “dot plot.” It will also be important to look at the Statement of Economic Projections (SEP) for changes from the March release. The SEP may indicate a lower unemployment rate projection for this year to account for jobs market strength and a potential uptick in core PCE projections (core PCE is one of the Fed’s preferred inflation gauges). This combination could suggest to markets that a pause does not preclude further rate hikes if the data demand it.

One way to reconcile contrasting views within the Committee would be to pause rates at this meeting, but to raise the “dots” indicating the Fed members’ future interest rate expectations for 2023 and 2024. This action would signal an intention to leave rates higher for longer, while also giving the doves on the committee another few weeks to prove that inflationary pressures are waning.

We believe the main message for markets should be that the Fed remains committed to bringing inflation down, will raise rates further if necessary to achieve that goal, and does not intend to start cutting rates anytime soon. Chair Powell is likely to repeat that the Fed is data-dependent, and that it will make future policy decisions on a meeting-by-meeting basis.

Against this backdrop, we maintain a least preferred stance on global and US equities. The expected US growth slowdown in the second half could hurt corporate revenues. We forecast year-over-year corporate earnings contractions and believe consensus earnings estimates are too bullish. And equities look less appealing from a valuation standpoint, both relative to their own history and versus fixed income.

We therefore suggest investors seek quality income in high grade (government) and investment grade debt, while potentially using structured investments to insulate equity positions from continued economic uncertainty and potential stock market declines.