Have we peaked?

The 0.25-percentage point rate hike at May’s Federal Open Market Committee meeting brings the target range of the fed funds rate to 5% to 5.25%.

The removal of wording that “The Committee anticipates that some” additional policy firming may be appropriate is a clear indication that the FOMC expects May’s increase to be the last of this tightening cycle. This aligns with Moody’s Analytics latest baseline forecast, which calls for a pause beginning in June.

Amid another bank failure

For consecutive meetings, the FOMC convened shortly after the failure of a significant U.S. bank. Despite the unease in the banking sector, Moody’s Analytics, like other Fed watchers, was confident that policymakers would proceed with a final 0.25-percentage point increase to the fed funds rate.

With May’s policy announcement well-anticipated, scrutiny was on any indication that June’s meeting would bring a pause after 10 consecutive rate hikes. The postmeeting statement was relatively unambiguous; March’s statement that “some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive,” was softened to, “In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time….”

While this softening in tone leaves the door open for further hikes if incoming data warrant it, Fed Chair Jerome Powell referred to this as a meaningful change. The failure of First Republic Bank, around two months after Silicon Valley Bank and Signature Bank collapsed, has generated substantial anxiety in the financial system.

Minutes from March’s FOMC meeting show the Fed expects that the banking crisis, in addition to its year-long policy tightening, will act to tighten credit conditions enough to cause a recession. Despite this downgraded outlook, the central bank is confident in the financial system’s resilience and believes another hike was necessary to stamp out elevated inflation.

Putting the regional bank’s vulnerabilities aside, the FOMC can feel good about the U.S. macroeconomy’s reaction to its rapid policy tightening and where inflation is headed for several reasons. Primarily, the encouragement is coming from the labor market. March’s Job Openings and Labor Turnover Survey showed another sizable drop in job openings.

The quits rate, closely correlated with wage growth, ticked down to its lowest rate in nearly two years. Job growth is slowing but not collapsing. Though modestly, inflation is decelerating.

Moody’s Analytics expects the FOMC to pause at midJune’s meeting. We do not anticipate the first rate cut to occur until early 2024. Intermeeting data will likely show a slowing U.S. economy—decelerating job gains and easing price growth.

While it is Pollyannish to think we are in the clear, the failure of First Republic Bank, which had been on the radar since SVB’s collapse, is more likely a delayed consequence of the initial panic than an emerging vulnerability in the banking system.

Falling labor demand

The labor market is loosening as demand for workers continues to fall. The March Job Openings and Labor Turnover Survey showed a sharper-than-expected decline in job openings. At 9.6 million, job openings have fallen by nearly 2 million since December and are at the lowest level since April 2021. At the same time, the labor force has expanded by more than 2 million, according to the most recent jobs report, bringing excess labor demand, or the gap in labor demand — job openings plus employment—and labor supply, to its lowest level since September 2021.

More important, however, is the decline in the quits rate. While the quits rate remains elevated compared with the prepandemic average, it has fallen to its lowest point in nearly two years. Quits are particularly informative regarding wage growth because job switchers have captured far-higher pay increases since mid-2021 than job stayers, according to the Atlanta Fed’s Wage Growth Tracker. A sustained reduction in the quits rate would signal that a key source of upward pressure on wages is moderating.