Fed likely to skip next rate hike (Wednesday) but signal it's not done, economists say

After a historic flurry of interest rate increases, a divided Federal Reserve is expected to stand pat Wednesday but signal that at least one more hike is likely this year amid stubbornly high inflation and strong job growth, several top forecasters say.

But economists are unusually split over what the Fed will do and some believe officials could still agree to a quarter point hike if a report Tuesday reveals that inflation was stronger than expected last month.

"It is a very close call," Barclays wrote in a note to clients.

Others think the Fed is probably done hiking rates this year and will hint as much in its forecasts.

Just last month, the Fed telegraphed that it likely would pause in June and hold rates steady the rest of 2023, according to officials’ median forecast. The central bank has lifted its key rate from near zero to a range of 5% to 5.25% in 14 months to corral inflation, the most rapid spurt of increases in 40 years.

Fed Chair Jerome Powell said officials wanted to assess the delayed effects of the rate increases on the economy as well as the impact of deposit runs that triggered the collapse of three regional banks. The banking crisis, he said, has toughened lending standards and could weaken the economy, leaving less work for the Fed.

But Powell stressed that if the economy and inflation remain more robust than anticipated, officials wouldn’t hesitate to raise rates again.

The uncertainty over the central bank’s decision Wednesday reflects an economy that has sent mixed signals recently, but generally has been more resilient than anticipated. While most economists still expect a modest recession later this year, others have pushed back the timing of any downturn to 2024 or lowered the risk.

What is the current inflation rate?

A recent report showed consumer spending rose a healthy 0.8% in April and the Fed’s preferred  measure of overall inflation jumped 0.4%. That was up from 0.1% the previous month and it nudged the annual increase in consumer prices to 4.4% from 4.2%, below last year’s 7% peak but will well above the Fed’s 2% target.

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How is the economy doing now?

The economy grew a modest 1.3% in the first quarter but that was largely because of weak business stockpiling, a volatile category. Consumer spending grew a vibrant 3.8%.

Meanwhile, employers added a booming 339,000 jobs in May. And the number job openings surged to 10.1 million in April after falling to 9.7 million the prior month, indicating more sturdy job gains could lie ahead.

Yet the unemployment rate, which is based on a separate survey of households, rose from a five-decade low of 3.4% to a still modest 3.7% and U.S. employees are working fewer hours each week, possible signs the labor market is softening. Economists, however, typically place more stock in the job gains.

What is the rate of wage growth?

Annual wage growth ticked down from 4.4% to 4.3%, though that's still historically high. The Fed worries that companies typically pass along higher labor costs to consumers through higher prices.

What are economists expecting the Fed to do to interest rates?

Over the past month, some key Fed policymakers said the central bank probably would keep rates unchanged Wednesday but called the move a “skip,” rather than a “pause,” suggesting the Fed likely would hike again in July. That appears to be the prevailing view. Markets that predict what the Fed will do share that outlook as do several top economic research firms.

Goldman Sachs expects the Fed to pause Wednesday but signal one more quarter point hike is coming. The firm thinks officials will upgrade their forecast for economic growth and inflation Wednesday while lowering their estimate of the unemployment rate at the end of the year to 4.1% from 4.5%.

Meanwhile, the banking crisis is not hampering the economy as much as expected. Its has led to a moderate drop in lending, Goldman said, adding it’s “fairly confident that it will not deliver a recessionary blow.”

Goldman figures the Fed’s policymaking committee is sharply split, with six members projecting one more hike this year, six looking for more than one and six foreseeing a flat rate the rest of the year.

How the Fed can keep the federal funds rate unchanged

Others say the Fed will hold rates steady Wednesday and signal the likelihood of no more hikes in 2023.

“We see a very high bar for the Fed to resume hiking post-June and continue to expect it to be on extended hold” before cutting rates early next year, Morgan Stanley wrote in a research note.

While inflation and job growth are still elevated, both are cooling, the firm says. Wage growth is slowing and there are early signs that rent increases -- a big contributor to inflation -- are poised to slow more dramatically, Goldman says.

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How high will the Fed raise interest rates in 2023?

Barclays, however, thinks the Fed will pause Wednesday but signal two more quarter point rate hikes this year, including in July.

“We expect the (Fed) to deliver a loud and clear message that it has more work to do to slow the economy and rein in inflation,” Barclays wrote to clients.

In fact, if an inflation report Tuesday shows that a core measure – that strips out food and energy items – rose by more than the projected 0.4% in May, the Fed could even raise rates Wednesday, Barclays says.