Is the Fed likely to pause rate increases this month?

by Erik Ristuben, Russell Investments

Executive summary:

• U.S. debt-ceiling deal passes House, Senate
• Fed appears poised to skip rate hike in June
• Additional monetary tightening likely in Europe

On the latest edition of Market Week in Review, Chief Investment Strategist Erik Ristuben and ESG and Active Ownership Analyst Zoe Warganz discussed the passage of the U.S. debt-ceiling bill. They also chatted about the likelihood of the U.S. Federal Reserve (Fed) pausing rate hikes and the European Central Bank (ECB) continuing to tighten.

Congress passes debt-ceiling deal

Ristuben and Warganz began their conversation by noting that the debt-ceiling agreement struck between President Joe Biden and House Speaker Kevin McCarthy in late May was approved by both chambers of Congress—first by the House of Representatives on May 31, and then by the Senate late on June 1. Ristuben noted that the deal passed the House of Representatives with broad bipartisan support, but that as anticipated, there was some opposition from hardline politicians on both sides of the aisle.

“We expected there would be criticism from lawmakers on the far right and the far left, and that certainly came to fruition—but in the end, the bill passed by almost 200 votes,” he stated. The bill was also met with bipartisan support in the Senate, Ristuben added, ultimately passing by a 63-36 margin. “At the end of the day, the bill passed because the stakes were simply too high for politicians, markets and the economy,” he remarked.

Ristuben said that overall, the economic impact of the debt-ceiling agreement will be muted, with the agreed-upon cuts in spending likely to only shave off 0.1% or 0.2% of GDP (gross domestic product). “This is effectively a rounding error, and really doesn’t impact our U.S. recession probabilities,” he stated. Ristuben explained that he and the team of Russell Investments strategists see a 55% chance of a U.S. recession in the next 12 to 18 months—the same probability they had before the drama over raising the debt ceiling intensified.

Pause in Fed rate hikes appears increasingly likely

Shifting to the labor market, Ristuben noted that the U.S. employment report for May will be released by the Labor Department on June 2. He said that following April’s addition of 253,000 nonfarm payrolls, consensus expectations call for the U.S. economy to have added around 188,000 jobs in May.

Warganz asked Ristuben if a reading around this range, or a little higher, could have any impact on the outcome of the Fed’s policy meeting in mid-June. “Probably not,” Ristuben said, “as it seems pretty clear that the Fed is going out of its way to signal that it will pause its rate-hiking campaign later this month.” He explained that Fed officials have emphasized their belief that monetary policy is well into restrictive territory, and want to take a data-dependent approach moving forward.

This doesn’t mean that the central bank won’t decide to lift borrowing costs again in, say, July, Ristuben explained, but in his opinion, it’s pretty safe to say that a June rate hike is off the table. Furthermore, from his vantage point, the Fed is probably done with rate hikes for this cycle, he added. “Our view at Russell Investments is that with the cumulative impact of all the Fed rate hikes—500 basis points total since March of 2022—now actually showing up in multiple parts of the U.S. economy, the central bank is likely finished with rate increases,” he remarked.

Lagarde signals more rate hikes to come in Europe

Ristuben and Warganz finished with a look at the latest developments in monetary policy in the eurozone. Ristuben said that in recent remarks, ECB President Christine Lagarde made it pretty clear she believes the central bank has more ground to cover in order for monetary policy to reach restrictive levels. “Simply put, Lagarde doesn’t think rates are high enough yet to sufficiently bring inflation under control,” he explained.

Ristuben noted that inflation in the eurozone slowed to a 6.1% rise, year over year, during May—noticeably down from April’s increase of 7.0%. However, he cautioned that month-to-month inflation numbers can be fairly volatile, and that Lagarde probably has more insight into the data than most.

“While there are signs that inflation is improving in Europe, it’s probably not at a fast-enough pace. At the end of the day, I think it’s becoming more and more likely that the ECB will probably end up with a monetary policy that is as restrictive for Europe as the Fed’s is for the U.S.—in other words, a significantly restrictive policy,” Ristuben concluded.