Rate Hikes, Dovish Twists: The Fed and BoE – Balancing Inflation and Growth

We are only halfway through May, and it has already been an action-packed month for rates markets, both domestically and abroad. The Fed and Bank of England meetings, surprising economic data, and central bank commentary kept markets on their toes. Let’s look at the past few weeks in rates markets and explore what lies ahead, along with potential disruptions.

The Fed: hawkish with a dovish twist

Markets braced for a hawkish Fed meeting due to persistent inflation. By end of April, the expected Fed rate for 2024 jumped from 3.8% to 5%. Core CPI numbers came out higher than economist expectations for the last four readings, and as such, markets were preparing for a very hawkish Fed. While the Fed delivered, it could have been more aggressive.

Hawkish signals include the press release highlighting the “lack of further progress toward the Committee’s 2% inflation objective”, and Powell’s comments about data not providing greater confidence in inflation returning to target. He also removed references to loosening policy “this year” from his prepared statement. However, dovish hints emerged too – Powell dismissed calls for further hikes, and the announced quantitative tightening downward adjustment was larger than expected.

Market shrugs, but risks remain

The market reaction to the meeting was a bit of a shoulder shrug – those expecting a more hawkish tone saw rates fall slightly, with year-end rates forecasts now at 4.9%. With approximately 50bps of cuts expected for the rest of the year, we see a risk the Fed underdelivers on this mark, holding off on cuts until 2025. This disconnect between market expectations and reality is less dramatic than earlier this year, and within our most likely scenario (explored here: Rates Outlook), the trend of rising rates likely persists, with inflation’s stubborn persistent fueling this trend.

The obvious challenge? The labor market. This month’s data missed expectations, with unemployment at 3.9% (vs. 3.8% expected) and job growth at 175k (vs. 240k expected). Though weaker than hoped, these indicators remain strong. For now, we believe sticky inflation concerns outweigh labor market data in the Fed’s eyes.

Dovish shift at the BoE

The Bank of England followed the Fed’s lead, but with a more dovish tone. The Monetary Policy Committee (“MPC”) kept rates on hold at 5.25%, but the voting slipped from 8-1 in the previous meeting to 7-2, with Ramsden joining Dhingra in calling for a cut. The BoE’s statement signaled a potential shift – it emphasized consideration of “forthcoming data releases and how these inform the assessment that the risks from inflation persistence are receding.” Governor Bailey was on the fence about cuts at the next meeting, saying that a cut in June was “neither ruled out nor a fait accompli.” He did address market pricing, suggesting cuts to the bank rate could be “possibly more so than currently priced into market rates.” Similar to the reaction to the Fed, markets were virtually unchanged - we are still pricing approximately 60bps of cuts for the remainder of 2024.

UK rate cuts: a balancing act

While the UK appears more economically fragile than the US, justifying a larger scale of cuts, we still see risks to the upside. Recent economic data support this case:

• Positive signs: PMIs and GDP surpassed expectations (0.2% vs. 0%) – putting recession in the rear view for now, and unemployment remains stable at 4.3%.
• Inflationary concerns: Add to this the worryingly stubborn core inflation – recently printing 4.2% vs. 4.1% expected – and you start to see why the market may be getting ahead of itself. We also saw average earnings growth of 6% (highest since September 2022).

With better-than-expected economic growth, seemingly robust labor markets, and sticky inflation, it would be a brave MPC to cut aggressively, if at all.

Looking forward: data drives the narrative

Upcoming economic releases in both the US and UK remain as important as ever. Before the next central bank meeting, we have labor data and two CPI releases. Central bankers and markets will watch each release eagerly and dissect any Central Bank commentary that follows. Rates markets in 2024 have been defined by continuously pushing cuts further and further out. While some cuts remain priced in, the risks are evident – time will tell if the final cuts for 2024 will materialize or not.