Those cuts are coming, but likely not in March
Xiao Cui, Senior Economist Pictet Wealth Management.
Another FOMC, another whipsaw in markets. The Fed kept rates on hold at 5.25-5.50% and kept QT unchanged. As expected, the policy statement removed the tightening bias by dropping the reference to “additional policy firming” and switching to “any adjustments”. The committee essentially shifted to an easing bias by adding the guidance that “the Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent”. At the presser, Powell noted that the fed funds rate is likely at its peak, and if the economy evolves broadly as expected it will be appropriate to begin dialing back policy restraint “at some point” this year. This was initially interpreted as slightly dovish by markets.
March
However, 35 minutes into the presser, Powell made a hawkish turn by clearly pushing back on the odds of a rate cut as soon as March, suggesting that a March cut is not the Fed’s base case because he doesn’t think the FOMC will reach a level of confidence in inflation by the March meeting . He didn’t completely rule it out, noting it’s something to be seen.
Cutting criteria – inflation
What’s clear from the communication is that the Fed is ready to ease, but it just wants to be cautious and sees no urgency. The first rate cut is a “highly consequential” decision, and the Fed wants to avoid backtracking on policy. It is happy to see the progress in disinflation in the past six months, but is concerned this won’t be sustainable and is cognizant of the risk that “inflation would stabilize at a level meaningfully above 2%”. So the Fed would need more months (Powell refused to specify how many) of good inflation data to be sufficiently confident to start the cutting cycle.
What about growth?
Since the last FOMC meeting, inflation has dropped faster than the Fed expected but growth has surprised on the upside. The Chair didn’t seem concerned about strong growth as a problem for future inflation. In fact, he mentioned the Fed is “not looking for a weaker labor market”. This came in contrast to his previous comment that the economy would need a softer labor market to bring inflation down. But if we were to see an unexpected weakening in the labor market, “that would certainly weigh on cutting sooner”.
Balance sheet
The FOMC discussed about the balance sheet at this meeting and plans to have an in-depth discussion about it at the March meeting. We will know more from the minutes and Fedspeak in coming days. We expect March is a likely meeting for an announcement on QT. We expect the Fed could start tapering in May before ending QT in Q4.
Our view
In our view, continued disinflation and a weakening labor market would lead to a first rate cut in June, with one cut at each of the following four meetings this year. The risk is for a move as early as March (we are not completely ruling it out, though May is more likely as a risk) if inflation surprises to the downside relative to our forecasts, or if the labor market deteriorates significantly.
January FOMC statement, strikethrough comparison. Highlights ours.
Recent indicators suggest that growth of economic activity been expanding at a solid pace. Job gains have moderated since early last year but remain strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated.
In support of its goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent.
In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective. In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.
