The Federal Reserve is expected to meet on May 2nd or May 3rd to discuss the market conditions, the current economic situation, and more importantly, whether or not interest rates shall be raised once more. The last time that members of the board of the Federal Reserve met to assess the state of the economy in March 2023, very interesting outcomes followed. The first outcome was that the central bank raised interest rates. Following the rise of interest rates, it was expected that the credit market would tighten, asset prices would plummet, unemployment would rise, and inflation would decline. Credit market did tighten, indeed, but asset prices did not plummet, especially for growth stocks. The stock market showed a surprising resilience despite high-interest rates. Moreover, although economic growth slowed, it remained positive, as unemployment rate remained low, and more than 236,000 jobs were added to the economy, which showed that consumer demand and wages did not decrease as expected. However, the economy continues to “disinflate.”
Forecasted GDP Growth by Financial Institutions
Source: Bureau of Economic Analysis & the Federal Reserve
What is expected from the Federal Reserve this time? Not much. At least no drastic change is expected from the forthcoming meeting. The Federal Open Market Committee (FOMC), the Fed body which is responsible for setting interest rates and making monetary policy decisions, will likely deliver its third consecutive quarter of a percentage point rate increase and continue to allow assets to roll off of its nearly $8.6 trillion balance sheet in its year-long campaign to get inflation under control without sending the U.S. economy into a recession. This rate hike will, thus, bring these rates to 5.25%. Traders see just a 14% chance the FOMC will choose to not raise rates in May, suggesting that a rate hike in May could be the end of the Fed’s current cycle of interest rate increases.
This expected hike will not drastically affect market conditions however, since investors have already adjusted their psychology and behavior to the expectation that the Fed will pause after this meeting. Thus, we should expect asset prices to drop in the short-term and then rise again as demand will continue to increase despite these high rates. The Fed is also expected to continue its policy of quantitative tightening, in which it allows up to $60 billion in Treasury securities and $35 billion in agency mortgage-backed securities (MBS) to mature and roll off its balance sheet each month.
The Federal Reserve expects a recession by the end of the year: a recession that will not look like a conventional recession with an apocalyptic financial or economic crisis. On the contrary, this expected recession may look more like a soft landing rather than a hard landing. The signs of a conventional recession simply are not there. The labor market remains strong with a very low unemployment rate, corporate earnings for the first quarter of 2023 showed that many corporations have performed well and that consumer demand remains steady. But in the worst-case scenario, there is a real possibility that the United States enters a prolonged recession lasting well into 2024. This is if, after raising interest rates, all the economic indicators start to nosedive. Fed economists predicted that the economy would fully recover by 2025.