The Fed hits the pause button

The US Federal Reserve raised interest rates last Wednesday (May 3) for the 10th-straight meeting, bringing rates above 5% for the first time since 2007.

Ahead of this decision, the market had been focused on whether this would be the final rate hike of this current cycle. With the federal funds rate in the range of 5%-5.25%, the Fed has now matched what its March forecast suggested would be the peak in interest rates this year.

The 25 basis-point increase was accompanied by changes in the Federal Open Market Committee’s (FOMC) statement that imply a possible pause at the Fed’s next meeting in June, with a bias toward more tightening should inflation prove sticky.

The FOMC statement takes note of tighter credit conditions that will weigh on the economy and also includes a new policy paragraph that reads, “in determining the extent to which additional policy firming may be appropriate to return inflation to 2% over time, the committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

While sticky inflation is a risk, the Fed also faces financial instability risk linked to challenges in local and regional banks as well as a looming debt ceiling crisis, which will likely erupt right around the next policy meeting. In his remarks, Powell was careful to outline the risks linked to the United States not paying its bills on time.

Last Friday, the April jobs report showed the US labor market remains resilient, with more than a quarter million new jobs added to the economy last month as the unemployment rate fell to match its lowest level since May 1969.

The US economy added 253,000 jobs in April, with the unemployment rate unexpectedly dropping to 3.4%, according to Friday’s Bureau of Labor Statistics data. While the numbers are positive, the data also showed a shrinking labour force. Consequently, wage growth picked up, with hourly earnings rising 4.4% year-over-year in April.

Even with downward revisions of 149,000 jobs to previous March and February estimates, job gains over the last six months have averaged 290,000. The gains for April, while more than the market expected, suggest a slowing in momentum.

In policy statements, Fed Chair Jay Powell said there were signs that supply and demand in the labor market are starting to come into better balance, but “the labor market remains very tight.” While the Fed will not like the current tighter labour market conditions, it will likely focus on broader economic trends. We now expect the Fed to pause its rate hike campaign at its meeting on June 14 because of the risks to the outlook and to allow the economy to absorb the 500 basis points of rate hikes since March 2022.

Bank of Canada – Concern over service price inflation

The Canadian jobs market continues to remain robust. Employment rose by 41,400 in April, while the unemployment rate held at 5.0% for the fifth consecutive month. Part-time jobs accounted for all of the monthly gains, as full-time employment fell (-6,200).  Average hourly wages came in at 5.2% year-over-year, showing some moderation but still too hot for the Bank of Canada. 

Population continued to expand, with the 15+ demographic growing nearly 70,000 per month in 2023. This rapidly growing population is pushing up monthly jobs numbers. The Bank has highlighted the population changes in its policy discussion. When reading the employment number, headline job growth is likely less important than the unemployment rate and wages to understand labour market tightness.

The Bank of Canada is concerned about the stickiness of service price inflation. This is likely the biggest challenge in getting inflation down to 2%. The Bank has highlighted three things it sees as necessary to slow service price inflation:

• The labour market needs to rebalance, and wage growth needs to moderate.
• Businesses need to slow the pace and size of their price increases.
• Inflation expectations need to come down—too many people still believe inflation will be higher than forecasts indicate over the next two years.

These factors will be a major determinant of whether the Bank of Canada will continue to sit on the sidelines, or if it feels it needs to do more to get inflation closer to the 2% target.

Independent Opinion

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