Fed Plans A March Rate Hike, But Will That Be It?

In raising the Fed Funds rate 0.25 percentage-points at their February meeting, the U.S. Federal Reserve (Fed) noted that “ongoing increases will be appropriate” for future rate decisions. That’s in part because the Fed is looking for “substantially more evidence” that inflation is moving lower. It’s a pretty big clue rates are likely going up again in March.

Markets broadly agree but only in the short-term. Markets see a good chance that the Fed raises rates 0.25 percentage-points once again at their March 22 meeting. However, after that, the Fed and markets aren’t aligned.

The markets currently see just a 3 in 10 chance that rates go up again in May, assuming rates do rise in March, but Fed Chair Powell explicitly mentioned “a couple more rate hikes to get to the level we think is necessary” at the February meeting press conference. That’s imply a rise in both March and May and it’s one more than the market suspects will occur.

May 3 Fed Meeting

This sets up something of a showdown for the Fed’s May meeting currently. Central bankers don’t like surprises, so this is far enough away that the Fed could still change course from its implied, but data-dependent, plan to raise rates at that meeting.

A big clue will come from the Summary of Economic Projections (SEP) these are released every other Fed meeting. In December, those projections implied that the Fed would most likely hike in May. We’ll get an update to those projections on March 22 and it’s possible that shows an altered view from policymakers, or at least signals how many aren’t necessarily on board for a May hike. It’s possible any hike in May is not unanimous as the Fed gets into the real nuances of fine-tuning policy.

For the markets, the decline in inflation recently has been encouraging, but the Fed is not so sure, because inflation is still at fairly high levels and historically inflation has been slow to come down after spikes. Nonetheless, Powell did refer to the precise peak level of interest rates as a “fine judgement”. We’ll get more context when the minutes from the February meeting are released later this month too, however, it was a unanimous decision to raise rates in February, so it’s fair to expect most policymakers may be on the same page as Chair Powell currently.

Incoming Data

Of course, incoming data will shape the Fed’s thinking too. Perhaps key data to watch is inflation. We can expect CPI inflation for January on February 14 and then a reading for February will come before the Fed meets again too. Much of the recent easing of inflation has come from declining energy costs and that tailwind may have now moderated at least for oil. However, underlying inflation has come down too.

Housing

Importantly, housing costs have continued to rise in recent CPI inflation reports. The Fed expects house prices to moderate in the inflation data at some point in the coming months, in part because housing costs in CPI include a statistical lag effect. To the extent that occurs, it could bring down headline inflation sharply given the weight of housing in the CPI calculations.

Wages

Still, the Fed isn’t only concerned about inflation. The Fed is watching wage costs closely as a potential driver of inflation. That’s because the Fed is worried inflation may prove sticky above its 2% goal, and if wage costs continue to rise, maybe inflation won’t come down as fast as the Fed wants.

The other side of this is that the relatively hot jobs market is helping the Fed in its inflation battle to some degree. If the U.S. economy were weakening, then the Fed would be conflicted about raising rates, currently that doesn’t appear to be the case, at least if you look at the jobs market. That’s enabled the Fed to focus more on inflation fighting and be less concerned about economic weakness.

What To Look For

Another small hike from the Fed in March seems likely, unless we see abrupt changes in the economy. However, the decision at the subsequent May meeting is up for debate. The Fed currently plans to hike, though their tone is softening slightly, and the markets aren’t sure the Fed will follow through.

We’ll get more context on this with upcoming economic news and Fed speeches, though, most importantly, the Summary of Economic Projections released at the March meeting will give a relatively clear message as to what policymakers expect to do in May. The other question is whether the Fed actually cuts rates in 2023, the market views that as a distinct possibility later in the year, but the Fed certainly isn’t ready to discuss that yet.