Stephen Miller
As was pretty much expected, the Federal Reserve’s Federal Open Market Committee (FOMC) chose to keep the policy (federal funds) rate target unchanged at 3.5 – 3.75 per cent.
That was pretty much universally expected.
The Statement issued with the decision looked a little more “hawkish” than the market had anticipated.
Overall, the Committee looked to be relatively sanguine regarding economic activity growth and the labour market but noted that ‘inflation remains elevated relative to the Committee’s 2 per cent goal’ and that ‘the Committee will deliver price stability.’ There was no reference to the employment side of the Federal Reserve’s (Fed) mandate.
The phrasing of the Statement looked to be framed against a backdrop of a particular concern regarding the “stickiness” of inflation.
That was reflected in the projection materials. The central tendency of the Fed’s traditional inflation focus, the core private consumption expenditures (PCE) price index, is now thought to come in at 3.3 per cent for 2026 compared with 2.7 per cent in March.
Reflecting that the central tendency of the policy (federal funds) rate which was revised up to 3.8 per cent from 3.4 per cent in March. In terms of the “dot plot”, of the 19 participants, 9 saw at least one further increase in the policy rate (3 saw one increase, 5 saw two increases, and 1 saw three increases), 8 participants saw no change and 1 saw a reduction. Chair Warsh did not submit a plot.
In his press conference, Chair Warsh foreshadowed some potentially significant changes in current Fed decision-making processes. He announced the establishment of five taskforces that will cover key elements of the current Fed processes and practices. Those task forces will cover:
- Fed communication, including, presumably, the utility of the current “dot plot”.
- Management of the Fed’s balance sheet.
- How the Fed uses existing data and whether new information sources might provide more useful information.
- Productivity and jobs.
- Price / inflation frameworks, including drivers and the measurement of inflation.
- As mentioned, the markets have taken a view that the Statement is a relatively ‘hawkish’ one: equity markets are weaker as is the USD, bond yields mostly rose, particularly in the front-end.
The “hawkish” reaction is understandable.
For one thing half of the FOMC, via the “dot plot”, see a hike in the policy rate this year.
For another, the Statement and Warsh in his press conference, emphasised “price stability” with an implication that current inflation is too high. Chair Warsh in his press conference seemed to wish to reinforce the Fed’s credibility as an inflation fighter.
And finally, the Chair too exhibited no real disposition to do the President’s bidding, putting Fed independence on display.
However, my sense of the press conference was that Warsh was not necessarily signalling much about the future path of policy (not surprising given his disdain for forward guidance and, indeed, the utility of the “dot plot”).
In that context the bond market reaction may have reflected a market that was anticipating a more “dovish” disposition from the Fed Chair. In other words, bond market positioning was “the wrong way around”.
Indeed, on the “dot plot” Warsh noted in the press conference that when he reviewed the plots of his colleagues, he spotted they were in pencil, ‘the type with an eraser’ he said, suggesting that circumstances can shift quickly and that markets should be wary of their informational utility.
Moreover, the announcement of a series of taskforces and the implied changes in Fed processes suggests that the next Fed move is maybe more of an open question, as might be the ultimate impact on the bond market, particularly via the balance sheet taskforce.
RBA: stayin’ “live”
For what it is worth I think the RBA made the right call at Tuesday’s meeting.
With inflation showing signs of peaking, with the news flow from the Middle-East marginally less worrying, with the economy clearly slowing and growth narrowly based, with the labour market possibly at an inflection point and having raised the policy rate at each of the three previous meetings, a ‘pause and reflect’ made sense.
What also made sense was to reinforce ongoing concern regarding inflation.
That is despite the aforementioned better news from the Middle-East.
Jim Chalmers might have us believe that the Middle-East tensions and the ratcheting up of the price of oil is the primary driver of our current inflation challenge. That is partially true at the ‘headline’ level. But the reality is Australia has a structural homegrown inflation proclivity.
That much may be gleaned from the trimmed-mean inflation measure which excludes any strong upward impetus from oil prices.
Trimmed-mean consumer price index (CPI) inflation in Australia is currently running at 3.4 per cent. That means we’re currently competing with Norway for the highest developed country inflation crown. That is not a (developed) World Cup we should want to win!
By way of comparison, the trimmed-mean measure in the US is 2.9 per cent and that is with some tariff impact that doesn’t apply in the Australian context.
Treasurer Chalmers might seek to conceal that point in his public statements on interest rates and inflation, but the reality is much of the problem is our own doing.
That homegrown structural inflation proclivity reflects, inter alia, the interplay of regulatory creep in labour and goods markets that impose costs on businesses, part of which are passed on to consumers. The regulatory regime is also reflected in abject productivity growth making the task of inflation containment all the harder.
Ruchir Sharma in a recent opinion piece in the Financial Times noted that “populists of the left and right tend to push for lower interest rates but appear not to recognise that the people hurt most by the resulting inflation are their main constituents: the poor and middle class.”
That is something the Treasurer may wish to reflect on, not to mention his erstwhile mentor, Wayne Swan, who not long ago accused the RBA of “punching itself in the face”! Nice line, but Swan’s sentiment is not one that has aged well. Indeed, one might be tempted to reference glass houses. (Mea culpa: we’ve all been there!)
To be fair, the current state of affairs is not down to the current Federal Government. Rather it reflects a long-standing policy deficiency since the end of the Hawke-Keating and Howard-Costello eras. Governments (both State and Federal and Labor and Coalition) have long averted their eyes from addressing productivity enhancing policy measures. Just as importantly, little attention has been given to avoiding productivity diminishing measures attaching to (mostly well-intentioned but poorly thought out) regulatory oversight of labour and goods markets.
Sure, (to paraphrase the Prime Minister) people don’t sit around the kitchen table talking about low (or negative) productivity growth. But productivity remains central to enhancing standards of living not the least through mitigating inflation.
So, while looming cyclical fragility may have motivated the RBA’s ‘pause and reflect’, that Governor Bullock was clear that the policy rate might still need to be increased at a later date, reflects governments’ inability to support the RBA’s inflation battle with supportive structural policies.
In determining the course of the policy rate over coming months, the RBA faces considerable challenges having to negotiate a tricky (dare I say “narrow”) path between structural inflation factors and cyclical fragility.
Bank of England’ nothing to see here…yet
The Bank of England meets tonight.
In some ways the Bank of England calculus is similar to that faced by the RBA.
The economy is in a state of cyclical fragility, and the UK also has somewhat of a structural inflation proclivity. In many ways, the inattention to structural elements has been more egregious than that attaching to Australia and in that context it is surprising that inflation has at the margin been better behaved. That may be attributable to a deeper cyclical fragility.
In any case, a set of benign (relative to expectations) virtually seals the deal for no rate rise at this meeting.
Headline CPI in May was unchanged at 2.8 per cent (versus 3.0 per cent expected). Core inflation came in at 2.6 per cent, slightly up from 2.5 per cent in April, and a little below the 2.7 per cent expected. Services inflation remains somewhat problematic coming in at 3.7 per cent up from 3.2 per cent in April.
So, while inflation remains well north of the 2 per cent target, against a backdrop of more positive news from the Middle-East this week, the key inflation measures seem sufficient enough to forestall any potential increase in the policy rate at tonight’s meeting. That said, markets may continue to romance the notion of a policy rate rise given services inflation and the fact that the current measures are well north of the target.
By Stephen Miller, investment strategist
