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
Faced with persistent inflation that has raised concerns about the direction of policy, the Federal Reserve has become locked in a holding pattern that is likely to play out when the meeting concludes on Wednesday.
Markets expect there is virtually no chance that the Federal Open Market Committee, the policy-setting arm of the central bank, will announce a rate change. This will keep the Fed's key short-term interest rate in a range of 5.25%-5.5% for months – or even longer.
Recent commentary from policymakers and on Wall Street indicates there is not much else the commission can do at this point.
“Pretty much everyone in the FOMC is talking from the same script right now,” said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott. “With one or two exceptions, policymakers almost universally agree that inflation rates in recent months are too hot to warrant short-term action. But they are still hopeful that they will be able to lower interest rates later.”
The only news likely to emerge from the meeting itself is an announcement that the Fed will soon reduce the level at which it is reducing bond holdings on its balance sheet before ending a process known as “quantitative tightening.” all together.
Beyond that, the focus will be on interest rates and the central bank's unwillingness to budge for the time being.
Lack of trust
Officials from Chairman Jerome Powell to regional Fed bank presidents have said they don't expect to start cutting rates until they have more confidence that inflation is headed in the right direction and back on track. towards the annual target of 2%.
Powell surprised markets two weeks ago with harsh words about how committed he and his colleagues are to achieving that mandate.
“We said at the FOMC that we need more confidence that inflation will move sustainably toward 2% before [it will be] appropriate to ease policy,” he told a central bank conference. “The recent data clearly have not given us more confidence, but instead indicate that it will likely take longer than expected to achieve that confidence. “
The markets have actually done quite well since Powell made these comments on April 16, although stocks sold off on Tuesday ahead of the meeting. The Dow Jones Industrial Average was even up 1% in that period, with investors seemingly willing to live with the prospect of an environment of higher and longer interest rates.
But there is always the specter of an unknown person showing up.
That's unlikely to happen during the business portion of the FOMC meeting, as most observers believe the committee statement will show little or no change from March onwards. Still, Powell is known to have surprised markets in the past, and his comments at the press conference will be scrutinized because of the aggressive view taken by committee members.
“I doubt we're going to get anything that will really surprise market prices,” LeBas said. Powell's comments “were quite clear that we have not yet reached the threshold for significant further evidence of cooling inflation,” he said.
There has been plenty of data available lately to support that position.
The personal consumption expenditure price index released last week shows annualized inflation at 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 index as a better measure of inflation and focus more on the fundamentals as a better indicator of long-term trends.
Additional evidence came Tuesday when the Department of Labor said the employment cost index rose 1.2% in the first quarter, up 0.3 percentage points from the prior period and higher than Wall Street expectations of 1%.
None of these numbers match the Fed's goal and will likely prompt Powell to be cautious about where policy is headed, with a focus on the fading prospects for near-term rate cuts.
Except for one cut, hoping for more
Futures pricing sees only about a 50% chance of a rate cut as early as September and now expects only a quarter-percentage point cut by the end of 2024, according to CME Group's much-discussed FedWatch measure.
However, some on Wall Street are still hopeful that inflation data will show progress and allow the central bank to cut spending.
“While the recent upward inflation surprise has narrowed the path for the FOMC to cut this year, we expect upcoming inflation reports to be softer and still expect cuts in July and November, although even moderate upside surprises could further delay cuts “, says Goldman Sachs economist. David Mericle said in a note.
Wall Street economists are preparing for the possibility that the Fed will remain sidelined for longer, especially if inflation continues to surprise on the upside. Moreover, they said the prospect of higher rates after the presidential election – favored by former President Donald Trump, the Republican nominee – could be inflationary.
Moreover, Goldman is part of a growing chorus on the Street that believes the Fed's March projection for “neutral” long-term interest rates — neither stimulative nor restrictive — is too low at 2.6%.
However, the company does not see any interest rate increases coming either.
“We continue to think that rate hikes are quite unlikely because there are no signs of a real warming at the moment, and fund yields are already quite high,” Mericle said. “It would likely take a severe global supply shock or very inflationary shocks to policy before rate hikes become realistic again.”
Settle QT
One piece of news the Fed will likely make at the meeting is an announcement regarding its balance sheet.
The central bank has been rolling off up to $95 billion of maturing government bonds and mortgage-backed securities each month, rather than reinvesting the proceeds. The operation reduced the Fed's total assets by about $1.5 trillion.
Officials discussed reducing the amount of runoff “by approximately half from the recent rate” during their March 19-20 meeting, according to minutes of the session.
As reserves decline, bank reserves parked at the Fed would theoretically decline as institutions move their money elsewhere. However, a lack of Treasury issuance this year has caused reserve levels to rise by about $500 billion since the start of the year to $3.3 trillion, as banks park their money at the Fed. If reserve levels do not decline, this could prompt policymakers to extend QT.