A more balanced reaction function
Xiao Cui, Senior Economist Pictet Wealth Management.
We expect the FOMC to keep rates on hold at 5.25-5.50%, and keep quantitative tightening (QT) and other administered interest rates unchanged at its January meeting. There will be no new economic projections or updated dot plot, so the policy statement and Powell’s presser take on added importance.
The forward guidance in the policy statement is likely to move from a hiking bias to a neutral stance. Instead of referring to “any additional policy firming”, the FOMC could point to future policy adjustment, suggesting the next move could either be a cut or a hike. The risk is the FOMC keeps forward guidance unchanged, reflecting more concerns about a reacceleration in inflation and perhaps as a way to push back on the recent easing of financial and credit conditions.
A shift to a neutral policy stance should be mainly driven by disfinatlion, in our view. Although GDP and growth data have generally surprised on the upside, inflation has declined more than the FOMC expected, with core inflation falling to 2.9% YoY in December, its first 2-handle since 2021. Inflation momentum, measured in 3m and 6m annualized rates, has fallen below the Fed’s target. Although labor market headline data remain strong, underlying details suggest the labor market continues to cool in an orderly way, dampening concerns about overheating.
Chair Powell is likely to describe risks of overtightening and undershooting as coming into broad balance. Although we expect a shift to a neutral stance, Powell is likely to keep maximum optionality and refrain from committing to the timing of the first rate cut. He’s likely to repeat the wording used by Governor Waller, that the Fed would be methodical and careful in considering rate cuts.
There will likely be considerable discussion on tapering QT, and Chair Powell could provide a synopsis of these discussions, but not make any formal announcement to start slowing the pace of runoffs. He could describe the conditions about tapering around reserve balances and the reverse repo balances, but we’ll likely get more details in the upcoming Fedspeak and the minutes after the FOMC meeting. We expect the Fed could start tapering in May before ending QT in Q4. The Fed has announced it will end the Bank Term Funding Program when it expires in March, and will increase the borrowing rate in the interim to prevent arbitrage.
The first FOMC meeting of the year will see rotating voters from the regional Federal Reserve banks. There is a slightly hawkish bent of the new roster, but given the decline in dissents and the sway of the governors, we expect the rotation to be inconsequential to the overall policy stance. We will also get an updated statement on longer-run goals and monetary policy strategy. We don’t expect any changes this year, but the Fed will likely start discussions and hearings about its framework ahead of the 5-year framework review next year.
