• Fed signals no rush to start cutting

• Fed interest rate cuts are likely coming

• The Fed is now preparing the market for rate cuts when warranted by the data

The Federal Reserve held interest rates steady for a fourth straight meeting with the FOMC signalled it is in no rush to reduce rates. The decision to leave the target range for the benchmark federal funds rate unchanged at a 22-year-high of 5.25% to 5.5% was unanimous. The central bank also reiterated its intention to continue reducing its balance sheet by as much as USD95 billion per month.

In an important development, the Committee removed its implicit “bias” to tighten policy further in its post-meeting statement. That is, the statements that were released last autumn noted that the Committee would take into account a range of information when “determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time”. This sentence was tweaked slightly in December. January’s statement noted that “the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks” when “considering any adjustment to the target range for the federal funds rate”. The statement also noted 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”.

Fed Chair Jerome Powell threw cold water on hopes that rate reductions would begin in March as Powell reinforced his message by saying that based on January’s FOMC meeting he does not think it is likely that the committee will reach a level of confidence by the time of the March FOMC meeting. Powell said in the press conference that policymakers began discussing when to start slowing the pace of their balance sheet runoff, or quantitative tightening, at January’s meeting but plan to have a more robust conversation about in March (FOMC). Fed officials said the risks to achieving their employment and inflation goals are “moving into better balance”.

Fed interest rate cuts are likely coming

The language affirms that the central bank is almost certainly done raising interest rates after 16 months of aggressive hikes to tame high inflation and a rate cut is now far more likely than an increase. But the Fed also suggested it’s in no rush to reduce rates and wants to make sure inflation has been subdued for the long term before acting.

In the statement the central bank said “in considering any adjustments to the target range for the federal funds rate, the (Fed) will carefully assess incoming data, the evolving outlook and the balance of risks”. It pointedly added, “The (Fed) 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%”.

At a news conference, Federal Chair Jerome Powell said the language was intended to convey that a March rate cut has not been ruled out but is unlikely. "The timing of (the first-rate decrease) is linked to our gaining confidence that inflation is on a sustainable path down to 2%” and "I don't think it is likely (Fed officials) will reach that level of confidence by the time of the March meeting. It's probably not the most likely case”.

The Fed may hold off longer than expected

There’s little doubt that a slide in rates is on the way. In December, the Fed forecast three quarter-point cuts this year. The median 2024 dot signaled a year-end fed funds rate of 4.625%, implying 75 bps of easing next year. But exactly when the Fed will begin to reverse the historic run-up in borrowing costs and how swiftly it will do so is a thornier question.

We are not convinced the conditions will yet be in place to induce the FOMC to cut rates as soon as its March 20 meeting. Indeed, expectations that the Federal Reserve will cut rates at its March policy meeting faded fast on following comments from Chair Jerome Powell that all but guaranteed the central bank will keep interest rates steady in the near term. According to the CME FedWatch Tool, after the release of the Federal Open Market Committee's latest policy statement, which pushed back a bit on the possibility of near-term rate cuts, the odds had fallen to 46%, and after his comments, the probability of March rate cuts dropped to 36%. Fed-funds futures currently put the probability of a quarter-point rate cut at the Fed's May meeting at about 60%.

We look for the FOMC to cut rates by 25bps at its meeting on June 12. The Fed’s preferred core PCE metric has moved to 2.9% YoY, with the 3-month annualized figure having moved below the Fed’s 2% target (at 1.5%) in December. Powell noted the improvement but highlighted that “ongoing progress is not assured”. The need for further evidence that inflation will move to stabilize at 2% was the main theme of Powell’s press conference. The FOMC will receive four more PCE prints between now and June 12. The 1.5% annualized rate of change in the core PCE deflator over the past three months indicates that the year-overyear rate of core PCE inflation will recede further in coming months. Moreover, we look for monthly changes in the core PCE deflator to remain benign in the foreseeable future. In our view, the FOMC will feel confident three months from now that inflation is moving back toward 2% on a sustained basis. A rate cut in March is not out of the question, but we would probably need to see a small increase in January core PCE prices, due at the end of February, in conjunction with soft data on economic activity, to compel the Committee to move in March.

We believe the expectation for rate cut in March is premature. While the trend in inflation has been encouraging, the strength of the US economy has given the Fed a free option to wait longer before it cuts rates. Given this economic strength, and with global supply chain issues popping up again, there is risk that inflation could surge higher. This argues for greater patience – a sentiment echoed by Powell as he leaned against market pricing for earlier rate cuts.

Source: BIMB Securities Research - 2 Feb 2024