The Federal Reserve left interest rates unchanged at the first policy meeting of 2024, signaling that officials might not reduce the benchmark federal funds rate “until there is greater confidence” that inflation is inching toward the central bank’s target rate of 2 percent.
Fed Chair Jerome Powell told reporters during the post-Federal Open Market Committee (FOMC) meeting press conference that it is unlikely the central bank will pull the trigger on a rate cut in March.
“Based on the meeting today, I don’t think likely we will have a rate cut in March,” he said.
FOMC members noted that the U.S. economy has been expanding, adding that the labor market has moderated, but remains strong.
“Inflation has eased over the past year but remains elevated,” the Fed said in a statement.
Investors paid close attention to the mixed messaging in the rate-setting Committee’s language. Policymakers adjusted their tightening stance while also suggesting that they may not slash interest rates.
“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 FOMC statement said. “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.”
Since March 2022, the Fed has raised interest rates 11 times, lifting the benchmark policy rate to a more than two-decade high of 5.25 percent.
Soft Landing
Mr. Powell argued that the U.S. economy has not yet achieved a soft landing, contradicting the White House’s economic position on the issue.
“I would not say we have achieved a soft landing yet,” Mr. Powell said. “We have a ways to go to achieve a soft landing. We are not declaring victory.”
That said, the base case for the Fed is that the economy is healthy with a solid labor market, meaning “we can be careful as we think about rate cut timing.”
“The economy is broadly normalizing,” he added.
He noted that much of the reported economic growth “is due to post-pandemic healing” and “when that peters out, our restrictive rate will show up more sharply.”
When asked if it is safe to dismiss fears of a hard landing, Mr. Powell stated that “this is a good economy.” But, looking at the outlook, the Fed expects the economy will moderate, the labor market will rebalance, and 12-month inflation is getting closer to target.
“Overall, this is a pretty good picture.”
Treasury Secretary Janet Yellen recently declared in an interview with CNN that the economy reached a soft landing.
Market Reaction
The financial markets reacted negatively to the indication that the central bank is not quite ready to slash interest rates, with the leading benchmark indexes firmly in the red.
U.S. Treasury yields pared their losses midweek. The benchmark 10-year yield fell below 4 percent. The two-year traded at around 4.28 percent, while the 30-year bond slipped below 4.23 percent.
The U.S. Dollar Index (DXY), a gauge of the greenback against a basket of currencies, erased its losses and turned positive of the FOMC statement.
The delay in interest rates is not surprising, says Giuseppe Sette, the co-founder and president of financial market research firm Toggle AI.
“The passage above shows the Fed is thinking along its tradition: rates are not cut into an expansion until there’s a clear move south in growth and inflation,” Mr. Sette said in a note. “Until the slowdown, rates are okay to remain well above inflation.”
While inflation has slowed, the Fed is determining if the downward trend is sustainable, explains Greg McBride, the chief financial analyst at Bankrate.
“The Fed is certainly pushing back on the notion of a March interest rate cut, dashing investors’ hopes again, but keeping options open and remaining non-committal as a central bank does,” Mr. McBride said in a statement.
“Interest rates took the elevator going up but are going to take the stairs coming down.”
Peter Schiff, the chief economist and global strategist at Euro Pacific Capital, warned that “the inflation problem will” become bigger.
“The #Fed officially let everyone know it’s done hiking rates, but dialed back expectation for when it will start cutting,” he wrote on X. “I wonder how long it will take before the financial community realizes just how bad the #recession will be or how much bigger the #inflation problem will get.”
Inflation and Rate Cuts
Because of cooler inflation data, March rate cuts are “back on the table,” said Jay Woods, the chief market strategist at Freedom Capital Markets.
“Prior to this week’s positive surprise in GDP numbers as well as core PCE sinking below the Fed’s desired rate of 2.0 percent, there was a 50/50 chance of a rate cut in March. Now the data suggest cuts are back on the table,” Mr. Woods said in a note.
According to the CME FedWatch Tool, investors are pricing in a 60 percent chance of a rate cut at the FOMC policy meeting in March.
In the fourth quarter, the Fed’s preferred inflation gauge—the Personal Consumption Expenditures (PCE) price index and core PCE—showed progress.
PCE prices eased to 1.7 percent, down from 2.6 percent in the third quarter. Core PCE, which strips the volatile energy and food components, was flat at 2 percent during the October–December period.
Others are not as confident as the futures market that the central bank will pull the trigger on a rate cut as early as March.
“The Federal Reserve stands pat in March and keeps rates unchanged,” wrote Jeff Klingelhofer, the co-head of investments at Thornburg Investment Management, in an analyst note. “The market expects the Fed to cut rates proactively, but their well-telegraphed data dependency gives them pause.”
Reiterating comments from rate-setting FOMC members, Mr. Klingelhofer believes that the Fed will keep rates steady until there are consistent and “non-conflicting signals” of lower inflation data by early summer.
The Balance Sheet
The FOMC statement noted that the Fed will continue to reduce its holdings of Treasury securities, agency debt, and mortgage-backed securities.
When the coronavirus pandemic struck the country, the U.S. central bank sprang into action by slashing interest rates to zero and boosting the money supply by more than $6 trillion. In addition, the Fed expanded its balance sheet to nearly $9 trillion by acquiring Treasury securities, corporate bonds, and mortgage-backed securities.
After initiating the institution’s quantitative-tightening program nearly two years ago, policymakers began reducing its balance sheet holdings.
For the week ended Jan. 25, the Fed’s total assets stand below $7.7 trillion. This is still 83 percent above the pre-crisis level.
It is unclear what the monetary authorities’ endgame is for the balance sheet, whether a target date or a specific level. Several Fed officials have recently discussed what should occur this year.
Appearing at a Jan. 16 virtual talk with the Brookings Institution, Fed Gov. Christopher Waller argued that his colleagues could start considering slowing down the organization’s balance sheet-tapering efforts.
“I would say sometime this year will be a reasonable thing to start thinking about it,” Mr. Waller said.
Lorie Logan, president of the Federal Reserve Bank of Dallas, noted during a Jan. 6 International Banking, Economics, and Finance Association meeting that the central bank could decelerate the balance sheet runoffs to expand the initiative and diminish the odds of having “to stop prematurely.”
“Normalizing the balance sheet more slowly can actually help get to a more efficient balance sheet in the long run by smoothing redistribution and reducing the likelihood that we’d have to stop prematurely,” Ms. Logan said in prepared remarks.
While all the focus has been on interest rates, economists purport that the balance sheet also matters to financial markets.
In November, Fed Chair Jerome Powell conceded that quantitative tightening has contributed to the jump in long-term bond yields.
The 20- and 30-year Treasury yields have roughly doubled since the Fed’s tapering campaign was launched to above 4 percent.
Moreover, a June 2022 study by staff economists projected that a $2.5 trillion balance-sheet reduction equals a half-percent bump to the policy rate.
“Overall, the model predicts that reducing the size of the balance sheet by about $2.5 trillion over the next few years, as opposed to maintaining the size at its peak level, would be roughly equivalent to raising the policy rate a little more than 50 basis points on a sustained basis,” they wrote.
Reports suggest that the Fed plans to unveil a plan and communicate it to the financial markets. Until then, investors will have to navigate through the uncertainty and turbulence.
Mr. Powell confirmed to reporters that FOMC members will begin “in-depth” discussions surrounding the balance sheet runoff.
From The Epoch Times
