On the statement, there should be some changes in tone relative to the press release following the May 4 FOMC meeting. The Fed will likely first emphasize the undesirable persistence of inflation pressures seen in a red-hot May CPI report and continued very high energy prices. They may note that the decline in the unemployment rate has slowed but they will likely assert that labor markets remain very tight.
In the statement, they will very likely announce an increase in the federal funds rate of at least 0.50%. However, futures markets are now pricing in a virtually 50/50 shot of a 0.75% increase and, were they to do this, we would likely see both a further increase in short-term rates and a decline in long-term rates as investors bet more heavily on rate hikes in 2022 leading to recession in 2023.
The Fed’s Summary of Economic Projections should provide further insight into how they see the economy evolving. Relative to their mid-March forecasts, they may reduce their estimate of year-over-year real GDP economic growth in the fourth quarter of 2022 from 2.8% to 2.0%, largely reflecting the first-quarter slide seen in both real GDP and productivity. They may also increase their estimates for year-over-year headline and core consumption deflator inflation for the fourth quarter of 2022 from 4.3% to 5.5% and 4.1% to 4.2% respectively. Importantly, however, they are still likely to project declines in both growth and inflation in 2023 and 2024 and a relatively stable unemployment rate.
There will be more dots in the Fed dot plot this time around with the addition of Lisa Cook and Philip Jefferson to the Board of Governors. Even with this, however, a more hawkish message will likely be clear in the data, with the median forecast for the end-of-2022 federal funds rate likely to climb from 1.9% in March to at least 2.6% and possibly 2.9%. 2.6% would reflect 50 basis point hikes in June and July and 25 basis point hikes in the three remaining meetings of the year. 2.9% would presumably reflect an expectation that the September hike is likely to be 0.5% rather than 0.25%.
Finally, in his press conference, Chairman Powell will had the unenviable task of providing a balanced assessment of the economy, emphasizing that he still expects both inflation and economic growth to slow and advocating a steady approach to policy while, all the time, assuring the public that he appreciates how upset they are with inflation. But that is his job and it is very important that he provides this balanced perspective.
If he does so, both the short end of the bond market and the U.S. equity market could rally accompanied by a dollar decline. However, even if he doesn’t, and markets sell off further, investors would do well to focus on valuations. On Friday, 10-year Treasury yields rose to 3.17%, almost their highest level in a decade while the forward P/E ratio on the S&P500 fell to 16.3x, now below its 25-year average of 16.9x. Whatever short-term cyclical journey the economy takes from here, it should, within a few years, resume a brighter path of moderate growth, low inflation and high profitability. If it does so, investors may well be able to realize good returns on assets being sold today at a time of understandably negative sentiment.