Fed Watch - Easing bias still intact
The Fed kept monetary policy on hold today, but signaled that it would take longer to gain confidence that inflation is on its way back to 2%, in turn delaying the start of rate cuts. However, the Committee still sees a cut as being the more likely next move, not a hike. The FOMC also announced a slowing in its balance sheet runoff (QT).
The policy statement contained minimal changes, beyond the acknowledgment of recent firmness in inflation readings with the addition of the line “In recent months, there has been a lack of further progress toward the Committee's 2 percent inflation objective.”
In the press conference, Chair Powell maintained his recent hawkish tone, although judging from the reaction in financial markets, he was less hawkish than many feared. Specifically, although Powell was more equivocal than in recent times on whether rates have peaked, saying only that this will ‘depend on the data’, when asked about the prospect of a hike in rates, Powell said “it's unlikely that the next policy rate move will be a hike” and that the Fed would need ‘persuasive evidence’ that policy isn’t tight enough to make such a move. This made clear to markets that, despite the recent firm inflation readings, the Fed is not so worried at this point that it is about to abandon its easing bias.
Still, Powell acknowledged that the Fed is “now at a point where inflation is offering some signal”, given that we have had a full quarter of upside inflation surprises, though the signal being taken is that policy needs to stay at the current restrictive level for longer than previously thought, rather than that policy needs to be more restrictive. At the same time, Powell continued to point to the two-sided risks of monetary policy, stating again that lowering rates ‘too little or too late’ also risks unduly harming the economy.
When questioned on inflation dynamics, Powell refrained from giving clear guidance on when inflation would start to move lower again. He said that “wages probably need to slow to more sustainable pace,” but pointed to the continued easing in supply demand imbalances in the labour market, and he was not particularly worried by the strong Employment Cost Index reading that markets reacted to on Tuesday. He also acknowledged that the weak growth in market housing rates was taking longer to feed through to inflation than expected, but expressed continued confidence that this would ultimately happen.
Overall, while essentially endorsing the recent moves by financial markets to price out rate cuts, our sense was that Powell is continuing to give the data the benefit of the doubt and will be ready to pivot the other way if inflation were to turn around again over the coming months. Assuming the Q2 inflation data prove to be more benign than in the first three months of 2024 (as we expect - see ), we continue to see a pathway for the Fed to start gradually lowering rates from July.
Fed slows balance sheet runoff –As we had flagged in our , the FOMC went ahead and announced a slowing in the pace of its balance sheet runoff (QT). The monthly cap on the runoff in Treasurys has been lowered to $25bn per month (down from $60bn), while that of MBS stayed at $35bn, but all proceeds above that cap are now to be reinvested in Treasurys – in line with the Fed’s longer-term plan to gradually eliminate its holdings of MBS. In emphasising that this should have limited implications for the stance of monetary policy, Powell stated that the slowing in QT does not change the likely end-point for the balance sheet. Rather, the pathway to that end-point will be more gradual, giving the Fed greater leeway to respond to liquidity conditions, with a view to avoiding the market turbulence of 2018.