CIO Notebook: Fed Cautious as Economic Data Points to Patience

May 02, 2024

With still-robust economic growth and strong labor markets, the Fed has cover to be patient in its quest; the challenge lies in how patient investors can be.

As expected, the Federal Reserve (Fed) announced no change in the target range of the federal funds rate of 5.25 – 5.50% for the sixth straight meeting in a unanimous decision for the 15th straight meeting. The Federal Open Market Committee (FOMC) statement did outline a reduction in the pace of quantitative tightening: the cap on the amount of Treasuries rolling off the balance sheet on a monthly basis is to be reduced from $60 billion to $25 billion while the target for MBS was held steady at $35 billion.

More importantly in our view, however, a pause in progress in the disinflationary trend that appeared to be intact coming into 2024 was evident in the updated statement as the FOMC acknowledged that “there has been a lack of further progress toward the Committee’s 2% inflation objective.” The statement also repeated language that the FOMC is unlikely to cut rates “until it has gained greater confidence that inflation is moving sustainably toward 2%.”

In terms of the Fed’s dual mandate, the statement noted that the risks to achieving its goals on both inflation and employment “have moved toward better balance over the past year,” likely a nod to a decline in job openings, quits and wage growth over the last several months. As it relates to more recent data such as GDP and ISM Manufacturing PMI, which have been admittedly soft, the FOMC appeared somewhat unbothered by indications of a slowdown. In our view, this was evident from the opening line of the statement, which cited that “economy activity has continued to expand at a solid pace.”

In our view, during the press conference, Fed Chair Jerome Powell amplified four main takeaways:

  1. He believes that the next move for the Fed, when there is a move, will be a cut. Despite several opportunities to acknowledge that policy was not sufficiently restrictive or that the recent stalling of progress could lead to a re-acceleration in inflation, and, therefore, a hike could be necessary, Powell did not bite.
  2. It is clear that the FOMC is concerned about the lack of progress in terms of prices coming down. However, the FOMC believes that the current policy stance can still yield 2% inflation. He pushed back rather vehemently at the idea that higher rates should be more of a concern for the Fed given the impact on lower income consumers; rather, he stated that inflation is the true enemy and what the Fed will remain focused on fixing.
  3. Powell’s comments around the labor market speak to a continued emphasis on the dual mandate. While he acknowledged that wage growth was a significant factor in terms of the run-up in prices, he also noted that both immigration (and the increase in the participation rate) as well as productivity improvements could help to counteract that pressure even if the unemployment rate remains low. Powell also acknowledged that any meaningful, unexpected deterioration in employment could be the catalyst for more accommodative policy even if inflation remains stickier.
  4. Powell represented the apolitical nature of the Fed, challenging the audience to look back in terms of the Fed’s actions during election years. He also noted that the timeline for cuts will continue to be data-dependent and not contingent on timing of the election or any other exogenous factors.

Reaction to the press conference in the markets likely reflects the fear that Chair Powell would be more hawkish in his comments than he was; equities and bonds both rallied as 2-year yields fell. With that said, fewer than two rate cuts are being priced in at this point and we think it is difficult to see a path to more than three rate cuts by the end of the year without either the type of disinflation exhibited in 2023 and/or a deterioration in growth. With still-robust economic growth and strong labor markets, we believe the Fed has cover to be patient in its quest; the challenge lies in how patient investors can be as they wait for the stimulative impact that lower interest rates are likely to bring.


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