Commentary Directory

Fed, ECB, and Inflation in Focus This Week

Jacob Hess

June 12, 2023

Prepare yourself for a busy few days where the Fed and ECB will both make monetary policy announcements in the same week as their major inflation releases. At the next tier of significance, data for US retail sales, US PPI, UK employment, and Chinese industrial production & retail sales are also released

As of the morning of June 12th, the market has mostly decided that the Fed will keep rates unchanged this week. Fed Fund futures pricing assigns a probability of 76% to a Fed pause with the other 24% assigned to a 25 bps hike. This is unchanged from a week ago but down slightly from the 84.5% Fed pause probability a month ago in May. The truth is that the current likelihood of a pause or a hike could see a major shift after the CPI release on Tuesday morning. This is a symptom of being largely data-dependent despite Fed Chair Powell hinting that the FOMC would start to pull back from hikes starting in the summer.

So all eyes turn to May CPI. The consensus forecast is for there to be a slight increase of 0.2% MoM in the headline rate which will see it decline further to just 4.1% YoY. Core inflation is expected to continue to be more sticky, dropping just 0.2 ppts to 5.3% YoY. The monthly growth rate is just a tad lower than the most recent three-month average of 0.3% MoM and would come out to an annualized rate of 2.4% or just above the Fed’s pace. If these consensus conditions were met, it would likely be enough for the Fed to move forward with a pause.

My CPI estimates are in agreeance with the consensus. In previous months when the monthly pace of inflation beat estimates, there was a stronger services sector behind it. The results of the most recent May ISM Services PMI, which pointed to slow new order growth and a slight employment contraction as well as a deceleration in the increase of prices, suggest a slower monthly CPI pace can occur. My estimates of MoM headline inflation and MoM core inflation are 0.2% MoM and 0.3% MoM respectively. As these are consistent with a Fed pause, I stick with my initial forecast of that scenario playing out this week.

Wild Card: The Bank of Canada surprised hawkishly last week with a 25 bps hike when many thought that there was a good chance for a pause. On top of that, the communication from the BoC was that "monetary policy was not sufficiently restrictive to bring supply and demand back into balance and return inflation sustainably to the 2% target" which suggested that if there are no changes in the incoming inflation data, there might be another hike in July. The Fed has most definitely been observing this posturing and could take cues from it, especially since Canadian price and jobs data looked more dovish than the corresponding US data. Powell & Co. are undoubtedly separate from their peers at the BoC but much of central bank policymaking is being done in unison as no one wants to diverge from major trends and get punished (see the BoJ and the yen).