In this week’s meeting, the Federal Reserve Open Market Committee kept the Fed funds range unchanged at 5.25-5.50%, where it has been since last July. There were no dissents.
Despite no action, messaging remains closely-watched for future signals. The formal statement evolved a bit, noting that activity ‘has continued to expand,’ acknowledging strength in growth. A line was added to the first paragraph that was a bit hawkish with frustration: ‘In recent months, there has been a lack of further progress toward the Committee’s 2 percent inflation objective.’ Also, that employment and inflation goals ‘have moved toward better balance over the past year.’ A reduction in balance sheet drawdown was put into place starting in June, and was a bit deeper than expected, with the monthly runoff cap of Treasury sales being lowered from $60 bil. to $25 bil., which lowers some selling pressure in markets. There was no change in the MBS redemption cap ($35 bil.), with reinvestments being made into Treasuries. (It’s clear the Fed wants mortgages off the balance sheet.)
CME Fed funds futures markets had put the chances of no action today at 98%—it having risen over the past two months. (Briefly this morning, interestingly, a 1% chance of a 0.25% rate hike appeared.) For June (a long-assumed jumping-off point for policy easing), odds of at least one -0.25% cut had been as high as 60% a month ago, but now lie under 10%. September’s highest odds now point to no cuts, while those for December have now dipped to a single cut. The furthest-out estimate in Sept. 2025 have been volatile, now showing the highest odds for rates around 4.50%-ish, implying 3-4 total cuts from today’s level. Hopes for policy easing this year have fallen off a cliff, from early January’s assumed seven cuts to now only one. This reflects a simple narrative of still-decent growth and still-sticky inflation requiring ‘higher for longer.’ In fact, on the fringe, there are some calls for additional rate hikes to finally get inflation under control. Estimates for the long-term neutral rate have also evolved, with the Fed’s long-standing 2.5% anchor seen as maybe too low in a more persistent inflation era, with a number like 3.0% (or even a bit higher) seen as possible moving forward. The Fed has wrestled with these assumptions but is also guarding its own credibility in not wanting to tweak long-term targets based on short-term trends. The November election also throws a wrench into the plan, as the Fed would prefer to not make any policy moves seen as potentially benefiting either side, so timing could get tricky in the fall.
Economy. GDP growth for Q1 came in last week at a positive 1.6% annualized rate, but about a percent below expectations, and below the long-term trend pace of ~2%. Under the surface, consumption growth was stronger than the total suggested, being pulled down by inventories. Interestingly, the first estimate for Q2-2024 by the Atlanta Fed’s GDPNow tool came in at 3.9%, now revised down a bit to 3.3% this morning. The economy is still growing at a decent clip, even if not at last year’s fast pace still fueled by fiscal stimulus. Should slowing kick in, it could provide more ammunition to the Fed for a rate cut campaign, but that urgency doesn’t seem to be upon us yet.
Inflation. This focus of the Fed’s attention continued to improve from the summer 2022 peak (9%), but remains stubbornly high compared to target, with several upside surprises this year. The trailing 12-month CPI for March came in at 3.5% and 3.8% for headline and core (ex-food and energy), respectively. Their primary metric, core PCE, has been in the 2.8-2.9% area for the last four months. Within CPI, shelter has taken a fair share of the blame, although there are other pieces on the services side that have contributed, such as annual price adjustments for car insurance and health care. Some evidence of the unique shelter issue has been seen in other developed countries, which have lower weights to housing in their inflation calculations, and have experienced faster deceleration in inflation than in the U.S. However, foreign growth has also been weaker outright, which is a disinflationary force. The bottom line is inflation is still too high for the FOMC’s liking, per their comments about wanting to see at least several straight cooler reports before starting any easing. That mood shift was the primary driver behind the shifts in Fed funds probabilities in recent weeks. While inflation has dramatically improved from the worst of it, the last mile back to the ideal continues to be bumpy.
Employment. Labor has been a persistent bright spot of the economy. The unemployment rate for March fell back down again to 3.8%, along with still robust official nonfarm payroll numbers, and low jobless claims that point to a benign environment. However, some other measures like job openings (with some infill from immigration) and Challenger layoff reports have weakened at the edges. Wage growth has also decelerated a bit, which also has some positive inflation implications.
The Fed always reminds us that policy decisions are data-dependent, but this has been even more the case in the last few meetings. In contrast to strong messaging earlier in the year that cuts were just around the corner, still-robust economic growth and inflation have shrunk the odds of easing action this summer. Some Fed officials have even pointed to as far out as year-end or early 2025 for a starting point, in line with what futures markets believe. Consequences of a later timeline have included the drift upward in yields across the U.S. Treasury curve (especially in looking at real yields, although there are other fiscal factors at play also to elevate yields), and ongoing strength in the U.S. dollar (especially if the ECB begins cuts around June, potentially weakening the euro by comparison). These are in addition to keeping the cost of capital high, which eventually pressures economic activity generally and can hamper valuations for other risk assets, including stocks and real estate. On the other hand, eventually easing will lighten the load a bit for these cost of capital pressures. Then again, Fed officials have been publicly questioning how ‘tight’ current policy actually is—while difficult to measure in real time—with the evidence that conditions are rolling along just fine so far despite over 5% in rate hikes in a quick stretch, even with a policy lag. Historically, the 5%-or-so rate level is about ‘average,’ considering the extremes in both directions. Despite sentiment measures that have been lackluster for a while now, and some signs of slowing at the edges, overall conditions are not so bad out there at the moment.
Sources: CME Group, Federal Reserve Bank, U.S. Bureau of Economic Analysis, U.S. Bureau of Labor Statistics.
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