Federal Reserve Chairman Jerome Powell prepares to testify before the Senate Banking, Housing and Urban Affairs Committee on March 7, 2024.
Kent Nishimura | Getty Images News | Getty Images
With stubborn inflation raising concerns about the future direction of monetary policy, the Federal Reserve is caught in a holding pattern that will likely be reflected when it concludes its meeting on Wednesday.
Markets believe the likelihood that the Federal Open Market Committee, the central bank’s monetary policy-making arm, will announce a change in interest rates is close to zero. This will keep the Fed’s federal funds rate within a targeted range of between 5.25% and 5.5% for several months – or even longer.
Recent comments from policymakers and on Wall Street suggest there is not much more the committee can do at this time.
“Pretty much everyone on the FOMC is talking about the same scenario right now,” said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott. “With perhaps one or two exceptions, policymakers largely agree that inflation data in recent months is too warm to justify short-term action. However, they are still confident that they will be able to reduce rates later.”
The only news likely to emerge from the meeting itself is the announcement that the Fed will soon reduce the amount of bonds on its balance sheet before ending a process known as “quantitative tightening.” in total.
Additionally, the focus will be on interest rates and the central bank’s unwillingness to budge for now.
Lack of trust
Officials from Chairman Jerome Powell to regional Fed bank presidents have said they do not expect to begin cutting interest rates until they are more confident that inflation is moving in the right direction and back toward its annual target 2% is possible.
Powell surprised markets two weeks ago with harsh words about how committed he and his colleagues are to fulfilling that mandate.
“We said at the FOMC that we need more confidence beforehand that inflation is moving sustainably toward 2% [it will be] “It is appropriate to ease policy,” he told a central bank conference. “Recent data clearly has not given us greater confidence and rather suggests that it will likely take longer than expected to achieve that confidence.”
In fact, markets have held up fairly well since Powell made those comments on April 16, although stocks sold off on Tuesday ahead of the session. The Dow Jones Industrial Average had even gained 1% during this period, as investors appeared to be willing to live with the prospect of higher interest rates in the longer term.
But there is always the risk that an unknown person could appear.
This is unlikely to happen during the business portion of the FOMC meeting, as most observers expect the committee’s statement to show little to no changes from March. Still, Powell has a history of surprising markets, and his comments at the news conference will be scrutinized for how hawkish the committee members’ views are.
“I doubt we’ll get anything that will really surprise market prices,” LeBas said. Powell’s comments “made it pretty clear that we have not yet reached the threshold for significant further signs of slowing inflation,” he said.
There has been a lot of data recently to support this position.
The consumer spending price index released last week showed an annual inflation rate of 2.7% when all items are included, or 2.8% for the all-important core measure that excludes food and energy. Fed officials prefer the Commerce Department’s index as a better measure of inflation and focus more on the core as a better indicator of long-term trends.
Further evidence came on Tuesday when the Labor Department said its labor cost index rose 1.2% in the first quarter, up 0.3 percentage points from the previous period and above Wall Street’s 1% forecast.
None of these numbers are consistent with the Fed’s goal and will likely prompt Powell to be cautious about further policy, with an emphasis on the fading prospect of rate cuts soon.
Except for one cut, I hope for more
According to CME Group’s widely followed FedWatch measure, futures market pricing sees only about a 50 percent chance of a rate cut as early as September and now projects only a quarter-percentage point cut by the end of 2024.
However, some on Wall Street are still confident that inflation data is showing progress and will allow the central bank to cut interest rates.
“While the recent positive inflation surprise has narrowed the path for an FOMC rate cut this year, we expect upcoming inflation reports to be weaker and still expect cuts in July and November, although even moderate positive surprises will offset the cuts could delay further,” Goldman Sachs economist David Mericle said in a note.
Wall Street bank economists are preparing for the possibility that the Fed could stay on hold for even longer, especially if inflation continues to surprise on the upside. In addition, they said the prospect of higher tariffs after the presidential election – favored by former President Donald Trump, the Republican nominee – could be inflationary.
Additionally, Goldman is part of a growing chorus on the Street that believes the Fed’s March forecast for the long-term “neutral” interest rate – neither stimulative nor restrictive – at 2.6% is too low.
However, the company does not expect any interest rate increases.
“We continue to believe that interest rate hikes are unlikely as there are currently no signs of a real recovery and the key interest rate is already quite high,” Mericle said. “It would probably take either a serious global supply shock or very inflationary policy shocks for interest rate hikes to become realistic again.”
Handle QT
One piece of news the Fed is likely to make at the meeting would be a balance sheet announcement.
The central bank has allowed up to $95 billion in Treasury bonds and mortgage-backed securities to expire each month instead of reinvesting the proceeds. The operation reduced the Fed’s total holdings by around $1.5 trillion.
At their meeting on March 19 and 20, officials discussed reducing runoff “by about half from the recent pace,” according to meeting minutes.
Because this reduces holdings, bank reserves parked at the Fed would theoretically decline as institutions move their money elsewhere. However, with banks parking their money at the Fed, the level of reserves has risen by about $500 billion since the start of the year to $3.3 trillion, as few Treasury bonds have been issued this year. If the level of reserves does not fall, this could prompt policymakers to extend the QT.
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2024-04-30 19:34:12
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