Below you will find a new commentary by Xiao Cui, Senior Economist Pictet Wealth Management, on the FED.
The Fed kept rates unchanged and announced a tapering of QT starting in June, as expected. Chair Powell was dovish relative to market expectations. Notably, the Chair pushed back on rate hikes noting “I think it’s unlikely that the next policy rate move will be a hike”. Markets welcomed the comment as it removes a hawkish tail risk for now. He still views the current stance of monetary policy as restrictive, and sufficiently restrictive over time. The policy statement retained a soft easing bias. Chair Powell noted his personal expectation is still of disinflation this year, although that confidence is now lower after recent stronger-than-expected inflation prints.
Powell repeated that it will likely take longer than previously expected to gain greater confidence on inflation before cutting rates. The Fed’s strategy now to deal with elevated inflation is to hold policy rates as long as necessary. We continue to view the bar to a resumed rate hike to be high. It would likely take a major reacceleration in inflation, not just inflation stalling out at a higher level, to prompt the FOMC to reconsider hikes.
Powell refuses to provide any hint on the timing of the next policy move, suggesting a high degree of data dependence. He suggested if inflation were to move sideways, it would be appropriate to hold off on rate cuts. He noted paths to cutting this year, which would involve inflation coming down convincingly or the labor market weakening unexpectedly. He later noted “a couple tenths” of an increase in the unemployment rate doesn’t count as an “unexpected weakening”. He also suggested there are paths to no cutting this year. The Fed remains highly data dependent and each inflation report will be as important as the last one.
In our view, rate cuts are delayed not derailed. We expect gradually slowing inflation and a modest slowdown in demand (to a still solid pace) to get the Fed to ease twice this year, but risks are skewed towards later and fewer cuts this year and next. Solid domestic demand and elevated inflation suggest the Fed will take a patient approach to policy adjustment.
The FOMC announced a slowdown in the pace of balance sheet runoff starting in June and Powell repeated this decision is independent of the monetary policy stance (i.e. not a signal of policy easing). The monthly cap on Treasury runoff will be reduced from $60bn to $25bn (slightly more than consensus expectation of reduction by half), while the cap on MBS will stay unchanged. The Fed will reinvest any principal payments from MBS in excess of this cap into Treasury securities, in line with their longer-term goal. However, the cap on MBS is unlikely to be binding unless interest rates plunge. Tapering of QT now does not necessarily mean the balance sheet would shrink by less than otherwise as the committee wants to approach the ultimate level more gradually, i.e. slower for longer.
