Inflation in the United States slowed in March, reducing the likelihood that the Federal Reserve will raise interest rates again next month.
According to the US Bureau of Labor Statistics, annual headline inflation in the United States decreased from 6% to 5% in March, below expectations of 5.1%, as monthly inflation declined from 0.4% to 0.1%.
Before the release of the data, markets had priced in a 73.8% probability of a 25 basis point increase in the Federal Funds Rate at the May 3 Federal Open Market Committee meeting.
CME Group data indicates that within minutes of the release, this percentage dropped drastically to 66.2%.
With the United States setting the tone for the rest of the world, rate watchers in the United Kingdom will interpret the shift as reducing the likelihood of future Bank of England rate hikes.
The markets continue to anticipate that the Fed will increase its Federal Funds Rate range from 4.75 to 5% to 5 to 5.25 percent, while 33.8% anticipate no change.
Richard Flynn, managing director of Charles Schwab UK, stated, ‘Today’s decline in the inflation rate is likely to be welcomed by investors, who may speculate that the Federal Reserve will shortly halt its cycle of monetary tightening.
He cautioned that while inflation is falling, it is still well above the Fed’s 2% target, and the central bank “may decide that additional tightening is necessary to achieve its target.”
Daniel Casali, the chief investment strategist at wealth manager Evelyn Partners, stated that there is a chance the Federal Reserve will “overtighten policy” with additional rate increases, which could lead to “a financial crunch in the banking sector.”
Although pockets of inflation remain in the economy, the Fed Funds rate is now higher than Fed projections of underlying inflation, and this positive real interest rate indicates that policy is already restrictive.
‘However, the Fed will be cognizant of the fact that there are inflation drivers beyond its control, namely petroleum prices. Recent OPEC production cuts have boosted crude oil prices and made it more difficult for the Fed to reduce inflation.
So, despite FOMC members’ hawkish rhetoric, the Fed may be reluctant to raise rates excessively.
Casali also noted that the Fed’s rate-cutting expectations for the end of the year are at odds with market expectations, as indicated by futures markets.
There is a 94.5 percent probability that the target rate range will fall by the Fed’s December meeting, with a 36.3% chance that it will be between 4.25 and 4.5 percent and a 30.1% chance that it will be between 4 and 4.25 percent.
Even so, markets presently price an 8.25% chance of a 3.75 to 4% range.
Isabel Albarran, investment officer at Close Brothers Asset Management, stated, ‘While only one more hike is priced in for this year, the Fed’s already-executed tightening still requires time to feed through to the economy, and we anticipate growth and employment to cool further.
Futures pricing indicates that by the beginning of 2024, rates will be 50 basis points lower than they are today. To justify such action, growth would have to decelerate considerably.
What about the British Bank?
On 11 May, the BoE’s Monetary Policy Committee will meet, and the market has almost entirely priced in a 25bps increase in the base rate to 4.5%.
ING analysts stated, “The market assigns an 80% probability to this outcome, whereas our team believes the BoE will maintain its status quo.”
Governor Andrew Bailey, who lectures in Washington today, will provide insight into the most recent BoE thinking. There is a possibility that he will allude at a pause, as central bankers in Australia and Canada have done in recent months.’
