Friday Roundup: Inflation Remains Key Focus, Rate Hike Inbound

Slowing GDP and persistent inflationary pressures have prompted debates on the appropriate policy response. The market expects more rate hikes late into 2023. Jerome Powell gets pranked.

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The trend of slowing GDP and persistent inflationary pressures in the U.S. and eurozone have prompted debates on the appropriate policy response among economists and central bank officials. Both the Federal Reserve and the European Central Bank continue to face the challenge of addressing these inflationary pressures, while attempting to navigate an environment of decelerating growth. This week in the United States, personal consumption expenditure (PCE) and quarterly GDP data came in, presenting a stagflationary cocktail to market participants. GDP read at an annualized 1.1% in the first quarter of 2023, far less than the median forecast of 1.9%. Concurrently, the core PCE price index — the Fed’s preferred inflation gauge excluding food and energy — accelerated to 4.9% as it was driven by a tight labor market through the first quarter of the year. 

With unemployment at a mere 3.5%, rising labor costs strengthen the case for another interest rate hike at the Fed’s upcoming meeting on May 3. Our base case remains that the Fed’s tightening regime will continue until it manages to break the back of inflation and/or the real economy, with the overwhelmingly likely case that both options are one in the same.

With the stall in first quarter GDP and annualized inflation still running far above the Fed’s 2% target, the stagflationary scenario continues to get priced into the market. Economists are forecasting second quarter GDP to come in at a very underwhelming 0.2%, while the Fed’s data-driven GDPNow estimate for real GDP in the second quarter stands at a more optimistic 1.7%. 

What does the market predict for the upcoming Fed meeting? Let’s take a look…