May FOMC Preview, the last 25bp hike as attention turns to the debt ceiling?: The MUFG Global Markets Podcast

George Goncalves, MUFG Head of U.S. Macro Strategy, thinks that given the macro to markets setup, the Fed shouldn’t be hiking at this point, but they likely will, so long as the rates market is pricing in over a 75% chance of rate hike come the time of the May FOMC rate decision meeting conclusion. Thus, the Fed is on track to deliver another 25bp hike and take up the range for the Fed Funds target rate to 5-5.25%. That said, he also believes that this could ultimately be the last hike of what was one of the most aggressive Fed hiking cycles in recent history.

The continued slide lower in U.S. economic activity with ongoing improvements in inflation measures, coupled with renewed banking turmoil and a more pressing U.S. debt ceiling impasse ahead warrants a pause, but again the Fed will likely hike at the May meeting. Therefore, Chair Powell will try to convey a neutral message and not sound overly hawkish or dovish at this juncture. We expect the presser to be dominated by regional bank concerns, especially after witnessing another bank failure this year (and the third such bank failure happened days before the FOMC decision).

Overall, the Fed’s rate path from here is fraught with many challenges. For example, until financial conditions worsen (which we believe they will into the 2nd half of 2023) and/or if there were to be a cascading of bank related trouble in the near future, unless things are glaringly and perpetually bad, the Fed will try to look past the recent bank failures. Reason being is that they want to push back on the market pricing of rate cuts and hold the line – conveying that they are planning to hold rates “higher for longer” to ensure all these rate hikes are working at wrestling inflation closer to their 2% target. The tricky part will be that holding rates at these even higher rates levels will likely expose further weakness in the banking system and potentially the private credit sector as well.

Net, we won’t know for sure if this is the last rate hike – that will hinge on their assessment that enough has been done. The markets still have to contend with NFP and CPI ahead (which depending on the messaging from the Fed and the outcome of this upcoming data batch, could re-introduce some rate hike pricing into June). However, in our view the outlook will likely worsen from here and uncertainty may go up a lot if the debt ceiling process is taken down to the wire. If so, the key thing to watch post FOMC will be how Fed speakers react to the data and debt ceiling developments. 

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