CIO Notebook: Fed Steady Even with Inflation Clouds on the Horizon

March 20, 2024

The pivot that the Fed embarked on in November appears to still be in place and there is a desire to maintain economic momentum and to adopt easier monetary policy over the course of 2024.

Yesterday, the Federal Reserve (Fed) announced no change in the target range of the federal funds rate of 5.25 – 5.50% for the fifth straight meeting. While this was expected, we believe the importance of this particular meeting increased significantly over the last eight weeks as a flurry of somewhat conflicting economic data pointed to the need for greater clarity coming out of the Federal Open Market Committee (FOMC).

The widely reported, hotter-than-anticipated U.S. inflation prints for January and February coupled with continued strong non-farm payroll readings—tempered in part by an uptick in unemployment—have moved expectations for federal funds rate cuts from six to three in a matter of a few weeks. There was also some concern that expectations would need to move even lower based on the Fed’s restatement of the dot plot. In fact, the Fed maintained expectations for three rate cuts this year, implying a target funds rate of 4.6% by the end of 2024. However, the dot plot does reflect one less rate cut in 2025, for a year-end target of 3.9%; this perhaps reflects an assumption that economic growth is more sustainable. The most notable change came from the longer end of the dot plot, as Fed officials see the long-term level of rates settling at 2.6%, from 2.5%, which could be interpreted as an acknowledgment that shifting economic dynamics imply a higher longer-term neutral rate.

As for the economy, in the Summary of Economic Projections, forecasts for GDP growth in 2024 and 2025 increased to 2.1% and 2.0%, respectively, from 1.4% and 1.8%. In addition, core PCE is now expected to fall to 2.6% by the end of 2024 and 2.2% by the end of 2025 while the 2024 estimate increased from 2.4%. As for unemployment, the Fed expects to close this year at an unemployment rate of 4.0%, down slightly from the December report, with unemployment reaching 4.1% by the end of 2025. When combining these new estimates, it is evident that the Fed acknowledged the recent uptick in inflation and other underlying measures in its expectations, but that recent data was not impactful enough to undercut the confidence that has already been built up to support rate cuts this year. We believe there are four important takeaways from yesterday.

First, during the press conference, Chairman Powell reiterated that the Fed remains committed to the 2% inflation target and that decisions to move toward more accommodative policy will be based on data. Powell appeared to want to avoid laying out a prescriptive timeline for cuts. While he admitted that the first cut was an important step, he attempted to downplay the notion that one cut would be followed by multiple cuts at predetermined intervals.

Second, Powell addressed the stickiness of shelter prices, acknowledging the slow pace of improvement in the underlying measures of shelter prices that feed into CPI and PCE. However, he also acknowledged the more recent softening of current rents, which he believes will begin to affect the shelter component, although the timing of that is difficult to pinpoint.

Third, Powell opened the door for the labor market to remain strong without triggering renewed concerns about wage growth. He stated that he does not believe that wages were the primary driver of the inflationary surge and that while non-farm payrolls have grown at a robust pace, demand has been better met by supply more recently. He also cited the influx of new workers as the potential for continued growth in consumer spending, thus fueling the U.S. economy at large.

Finally, Fed Chairman Jerome Powell stated that while there were no changes in balance sheet management in this meeting, he admitted that the FOMC is likely to slow the pace of balance sheet runoff “fairly soon”; however, he noted that it is the belief of the FOMC that slowing the pace of the runoff could eventually result in a greater reduction of the Fed’s bond holdings.

In summary, equity and bond investors likely exhaled a sigh of relief as the press conference ended; the pivot that the Fed embarked on in November appears to still be in place and there is a desire to maintain economic momentum and to adopt easier monetary policy over the course of 2024. In terms of reaction, equity markets traded higher following the statement and the gains accelerated throughout the press conference while bond yields fell modestly as well. Fed expectations, according to the CME FedWatch Tool, moved on today’s news: the probability of a rate cut in June now sits at 68%, up from 56% yesterday. We remain positioned for slowing yet still positive economic growth, consistent with the Fed’s outlook, and continue to recommend a rotation from cash and short duration fixed income positions to longer duration fixed income, equities and private market strategies given the probability of a decrease in short-term yields over the course of the year.


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