The Fed is unlikely to close the doors for hikes.

• The markets are pricing in a small 25% chance of a 25 bp increase, which is what we anticipate the Fed to do next week.
• Communication of a probable hike in July and the revised dots will be the focus. Although the Fed is unlikely to forbid rises, we don’t think they’ll happen.
• We predict headline CPI of +0.2% m/m (4.2% y/y) and core CPI of +0.3% m/m (5.2% y/y) and see downside risks to consensus expectations for May CPI.

Market attention has been on the resurgence of economic momentum, which has brought back concerns that inflation will become more persistent. Although there is an indication that underlying inflation is continuing to steadily decline, we do not believe the rise in leading indicators will last.

Although the May NFP surprised to the upside significantly, the supporting facts were much weaker. Sectors like leisure and hospitality, which have long struggled with a labour shortage, are significantly represented in the employment rise. Employment increases as labour force participation improves even while overall labour demand is declining. However, it’s vital to note that supply-driven employment growth is not inflationary; on the contrary.

Due to the 310k decrease in employed workers and the 130k increase in the labour force, it is possible that the labour market is now experiencing some slack. Because of this, pay sum increase is still declining, and our preferred indicator of underlying inflation, the core services CPI & ex. housing & health care, has stabilised over the past two weeks.

We anticipate that the May CPI, which will be reported right before the FOMC meeting, will slow to 0.2% m/m (4.2% y/y) due to the negative impact of oil prices. We also anticipate that Core CPI will continue to decline, reaching 0.3% m/m (5.2% y/y). Used vehicle prices and manufacturing PMI price indices indicate that the core goods CPI’s April increase will not be maintained, and we also expect the core services and housing components to continue to drop gradually.

Markets have increased the likelihood of a hike in July from 75 to 80 per cent. Notably, to raise the median ‘dot’ to 5.25-5.50%, only two individual FOMC members would need to raise their 2023 rate estimates, which would cause a hawkish initial reaction in the markets. We continue to believe that the hurdle for beginning increases in July will be high, barring a noticeable acceleration of the summer’s inflation pressures. Although real disposable income has fallen precipitously, private spending has so far proved remarkably robust.

However, since surplus savings will eventually run out, we believe the growth backdrop will stay weak.

Rate rises when inflation has already started to fall will be further discouraged by negative signals from longer-lead monetary indicators as well as the possibility of tightening liquidity conditions throughout the summer.

Holding nominal rates at 5% will keep the monetary policy stance appropriately restrictive, according to consumers’ falling inflation expectations, which are currently hovering around 4-5%.