Fed funds futures traders have increased their expectations for a pause by the Federal Reserve through at least June, after March’s producer price index showed the sharpest monthly decline in almost three years. Traders are now factoring in a 94.7% chance of a reduction in rates by year-end, according to the CME FedWatch Tool.
The Federal Reserve is closely monitoring inflation as it considers whether to continue with gradual interest rate hikes this year. A moderation in PPI, together with a slowdown in consumer price gains reported last month, support the Fed’s view that the recent jumps in inflation are likely to be transitory.
However, an acceleration in wage growth appears to support Fed officials’ assertion that weak inflation outcomes in GBP basis swaps, for instance, are likely to be transitory. The recently released minutes of the March 20-21 meeting of the Federal Open Market Committee (FOMC) showed that almost all Fed policymakers anticipated that the outlook for the U.S. and global economy would warrant raising rates at a faster pace than many analysts had thought likely some months ago, when data still showed slack in the U.S. labor market.
Yet, some analysts argue that the sluggish price growth in goods offsets the inflationary impact of services, and only goods prices are affected by monetary policy. This would mean that central banks should pay attention primarily to the prices of goods when assessing price growth to avoid “misattributing the effects of structural factors on services prices to transient factors.”
Moreover, the debate on the path of future interest rate increases has been further complicated by the ongoing trade dispute between the U.S. and China as well as other restrictive trade policies that could undermine economic growth. Despite robust growth in global trade over the past year, including in China, there are concerns that tariffs could raise import prices, which would probably feed into core PPI.
As a result, some economists are skeptical about the magnitude of the expected reduction in the interest rates given past mistakes the Fed made in 2013 when it began tapering its asset purchases, an episode popularly referred to as “the taper tantrum.” During that time, the U.S. central bank struggled to control the rapid rise in bond yields, and a similar situation could occur now if it moves too quickly in lowering interest rates.
In conclusion, the weak PPI data has heightened expectations that the Federal Reserve will pause its interest rate hikes through at least June, which is likely to keep the fed funds rate target at between 4.75% and 5%. Traders are also factoring in a 94.7% chance of a reduction in rates by year-end, according to the CME FedWatch Tool.
Treasury yields across the board fell after the weak PPI report, led by a decline in the 2- and 3-year yields. However, the uncertainties surrounding the current trade disputes and the potential impact on economic growth and inflation make it difficult to accurately predict the Fed’s next moves. The central bank will continue to monitor both domestic and global economic indicators closely and base its decisions on these factors, making any predictions of future rate hikes speculative at best.
