The May FOMC meeting begins – The Daily Tearsheet

Vital Statistics:

Stocks are lower as we begin the May FOMC meeting. Bonds and MBS are up.

The FOMC meeting begins today, and the Fed is stuck between a rock and a hard place with the potential tariff-driven increase in inflation and a slowing economy. The Fed’s instinct will be to hold off cutting rates as long as it can, which will probably mean it will be late to the game if a recession hits.

“This is not going to be a cycle where the Fed pre-emptively cuts because there’s a forecast of a slowdown. They’re going to actually need to see it in the tangible data, in particular the labor market,” said Richard Clarida, who served as Powell’s second-in-command for three years and is now a senior adviser at bond giant Pimco.

The subtext of that quote is “we will remain tight (i.e. above r-star) until the economy breaks. It sounds like further progress on inflation will be a necessary, but not sufficient condition to get down to r-star.

If that is the case, expect more attacks from Trump given that the Fed eased for Joe Biden [to help boost the economy heading into the election] when the economic justification was much thinner. If the inflation reports continue to show progress on inflation, the pressure will grow, and Trump will double down on the “Mr. Too Late” rhetoric.

The Fed thinks that it will be able to forestall a recession if it cuts aggressively. “Over seven years, the Powell Fed has a track record of waiting to be very sure about the data and then going very fast. I would imagine if you see a notable deterioration in the labor market, at that juncture the Fed will be prepared to move,” said Lael Brainard, who served as Fed governor from 2014 until 2023, including as vice chair during her last year.

In other words, if unemployment approaches 5%, you could see 100 basis points in cuts in two Fed meetings.

The ISM Services report came in stronger-than-expected, rising to 51.6 from 50.8 in March. New orders and employment both advanced, while business activity fell. The prices index also rose, which pushed up bond yields.  “April’s change in indexes was a reversal of March’s direction, with increases in three (New Orders, Employment and Supplier Deliveries) of the four subindexes that directly factor into the Services PMI^®. Of those four, only the Business Activity Index had a lower reading compared to March. Employment continues to be the only one of these subindexes in contraction territory, with two straight months of contraction. From December through February, all four subindexes were in expansion. Regarding tariffs, respondents cited actual pricing impacts as concerns, more so than uncertainty and future pressures. Respondents continue to mention federal agency budget cuts as a drag on business, but overall, results are improving.”