While the Fed is likely to cut interest rates 3-4 times this year, there is little in the data at this juncture to force a move in March.
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 fourth straight meeting. While interest rate policy is always in focus, expectations for a rate cut in this meeting were incredibly low. The focus, instead, was on the statement and the narrative communicated by Fed Chair Jerome Powell.
As a reminder, following December’s meeting, the Fed changed the language of the statement in an attempt to open the door for easing in the coming months; their January statement indicates that Fed watchers may need to be a bit more patient as they wait for that change. While acknowledging the reacceleration of U.S. economic growth in the fourth quarter, the Fed in their statement said it believes that “the risks to achieving its employment and inflation goals are moving into better balance.” However, the Fed also noted that it is unlikely to reduce the federal funds target rate “until it has gained greater confidence that inflation is moving sustainability toward 2%.” There were no changes to its previously announced plans to roll a maximum of $60 billion of Treasuries and $35 billion of mortgage-backed securities off of the balance sheet each month.
During the press conference, Powell delivered a more nuanced assessment of the Fed’s challenge:
First, he recognized that the last six months of inflation data is good enough to support a move towards more accommodative policy but that the Fed would like to see more months of data as confirmation. He also attributed much of the progress to the strong disinflationary trend in goods and noted that it would be necessary for services and shelter to contribute more to that trend in order to deliver the Fed’s goal.
Second, Powell stated that while the Fed had telegraphed that slower economic growth and a weaker labor market would likely be required to deliver target inflation, he believes that it is now possible that inflation could continue to decline even without a meaningful economic contraction and/or higher unemployment. While he was unwilling to use the term “soft landing,” we believe it is clear in the comments that the Fed sees the probability of that scenario rising over the past several months.
Third, Powell acknowledged that he believes the Fed is now in “risk management mode.” To cut rates, the Fed needs to have greater confidence that inflation and inflation expectations will anchor at 2%. He believes that the labor market is normalizing but expressed that a strong economy could reignite inflationary pressures – he also admitted that maintaining restrictive policy longer than necessary would be just as unwise.
Finally, he stated that while there were no changes in balance sheet management in this meeting, the Federal Open Market Committee intends to take up the topic in its March meeting. He also admitted that any changes to the federal funds rates and quantitative tightening could be done in tandem or independently.
Overall, while attempting to provide a balanced assessment of the economy and policy, it was Powell’s admission that he does not believe the Fed will achieve the level of confidence necessary to cut rates in March that drove Thursday’s market reaction. All major U.S. equity indices declined following the release of the Fed’s statement while yields moved higher following the press conference. Interestingly, despite these moves, CME Fedwatch expectations for a rate cut in the March meeting have changed little over the last week, hovering around a 40% probability for such a move.
Our view is that while the Fed is likely to cut interest rates three to four times this year, there is little in the data at this juncture to force a move in March. The impetus for such a move would likely be a sharp deterioration in economic data rather than a surprise in terms of inflation slowing more quickly than expected. The Fed is conscious of the risk of reaccelerating inflation and with the U.S. economy still strong, there is likely little downside to getting a few more confirmatory data points before embarking on what is likely to be a multi-faceted shift toward monetary policy normalization.
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