The FOMC Cha-Cha: Skip, Hike, Pause, Pivot

An unsurprising confession: I’ve never been a big fan of line dancing.  Yet the recent debate about the Federal Reserve’s potential next moves struck me as the instructions to perhaps the world’s lamest – but most critical – line dance.

For much of the past few months, markets were hopeful that the FOMC would pause in its recent pattern of sequential rate hikes, then pivot to rate cuts for later in the year after a peak was reached.  It was enough of a topic of conversation that in the aftermath of the March FOMC meeting, after a 25-basis point hike, we asserted that “peak and pause do not mean pivot.”  Our logic then – as now – was that the Fed would be highly resistant to beginning a rate cutting cycle almost immediately after ending a hiking cycle.  Unless of course, dire circumstances required a cut. 

Our thinking was echoed just a few weeks later by Philadelphia Fed President Harker, who was quoted on April 11^th as saying:

“But at this point, I don’t see why we would just continue to go up, up, up and then go, whoops! And then go down, down, down very quickly. Let’s sit there.”

As it turned out, the next step was indeed another hike.  The FOMC raised rates another 25 bp at their meeting in early May.  Correctly or not (we’ll know for sure in the coming weeks), Fed Funds traders decided that we were done with rate hikes.  A stable rate was priced in for June, and odds of a cut in July were greater than 50/50.  In other words, a pause and a pivot.  And the pivot was a major one, with over a full percentage point in cuts priced in by January.  Since then, however, the market then pivoted about the idea of an imminent pivot, with only a single cut priced in by the end of the year.

By the start of this week, as recently as Tuesday, Fed Funds futures were pricing near certainty for a 25 bp hike by July.  But even then, traders were unsure of whether the hike might occur at the upcoming meeting (less than two weeks away) or the next.  There was a 59% chance of a hike in June, but 99% for 25 bp by July.  That led to the notion that the Fed’s next step was to skip a hike at the next meeting, before a pause after July.  Fed Governor Jefferson made the following comment yesterday:

“Skipping a rate hike at a coming meeting would allow the committee to see more data before making decisions about the extent of additional policy firming,”

At a separate meeting yesterday, the aforementioned Harker added:

“I think we can take a bit of a skip for a meeting,”

With a skip seemingly entrenched as the Fed, let’s break down the steps as we see them today.  Fed Funds futures are currently pricing in about a ¼ chance of a hike in June and a 2/3 chance of a hike by late July.  That of course is down substantially from the near certainty that was priced in as recently as Tuesday.  Odds of a cut sometime in the December/January timeframe rose somewhat, but still remain centered around a single cut around then. 

The recent barrage of Fed talking heads is now coming to an end as they enter a quiet period ahead of the next meeting.  It seems reasonable that the FOMC will continue to assert their vigilance against inflation that remains well above their 2% target, while recognizing that monetary operates with a meaningful lag.  The final choreography remains in flux, but it appears that the next few steps are likely to be skip, hike, pause, pivot – even if the timing remains uncertain.  Everybody on the dance floor!