The economic expansion has advanced from the initial recovery, and the focus is now on metrics the Federal Reserve is looking at to gauge the health of the economy. Since the Fed’s dual mandate is to keep prices stable and maximize employment, we will focus on labor and inflation metrics, keeping in mind the broader economic impact as well. We created a Fed Monitor to track some of the data points that will impact the Fed’s decisions to tighten financial conditions. Additionally, we try to quantify the data and information outside of the dashboard to determine if the Fed is being more dovish than the data, and likely to be more aggressive in the future, or if they are being hawkish relative to the data, and likely to be more conservative in the future.

Fed uncertainty is heightened at the moment. Both the bond market and Fed funds futures markets are reflecting uncertainty about the path of rates. Bond yields have been extremely volatile this year and expectations for the path of interest rates have been in a wide range. The implied Fed funds futures rate by year-end rose as high as 5.60% in early March before bank closures rattled markets. Expectations dropped within a week to 3.88%, before settling near 4.50% recently. The Fed increased rates to a range of 4.75% to 5.00% in March and the odds are slightly in favor of another 0.25% increase at the upcoming May FOMC meeting (May 2-3). Markets expect rates to increase slightly near-term but decline by year-end. In the Fed’s FOMC Minutes from the March meeting, the Fed is concerned that issues in the banking system will cause a recession later this year. If a sharp economic slowdown occurs, the odds of rate cuts will rise substantially.

The economic data that is in focus by the Fed is trending in the right direction, albeit from elevated levels. The pace of labor market growth is still at a strong level this year, though monthly job growth eased to the lowest level since December 2020 in March. Labor market expansion is still above the pre-pandemic trend. Wage growth slowed further in March to a 21-month low, and job openings dropped as well. The trends in the labor market will help ease inflationary pressures on consumer prices. Looking at inflation data, the consumer price index (CPI) slowed to 5.0% Y/Y last month, the slowest in nearly two years. Core CPI inflation is remaining stubbornly high, but the trimmed-mean CPI slowed last month, indicating that inflationary pressures aren’t as broad based compared to the last few years.

We are maintaining the Fed-O-Meter dial left of center because we expect the Fed to become more dovish based on the economic data, tighter lending standards and their heightened concern over recession risks. There is a good chance the Fed increases rates by 0.25% in May, but it could be the final rate hike of the cycle. Labor market trends are normalizing, signs of disinflation are growing, and the full impact of the rate hike cycle hasn’t been felt.