Fed Rate Cuts Aren’t a Guarantee in May, Either

There was something for both the doves and the hawks in Wednesday’s Federal Reserve policy statement and subsequent remarks by Powell.

The Fed is trying to thread a tricky needle, nearly two years into its tightening campaign. Moving to lower rates too soon could cause inflation to reaccelerate. But waiting too long, even as inflation trends in the right direction, could harm the economy and increase unemployment.

A wait-and-see approach is the play for now—it’s simply too early to tell what the economy and inflation will do this year, and what the appropriate policy response will be.

“There’s just not a lot of rush to get this cutting cycle under way too quickly,” said Adam Abbas, co-head of fixed income at Harris Associates. “The growth data is OK, the labor market is good, inflation is cooperating—the incentives tilt toward being patient.”

The Federal Open Market Committee unanimously voted on Wednesday to hold the federal-funds rate steady at a target range of 5.25% to 5.50%. The committee’s postmeeting policy statement and Powell both signaled that—data permitting—the next move in interest rates will be down. But the exact timing of that move lower will require more demonstrated progress on moderating inflation.

“We believe that our policy rate is likely at its peak for this tightening cycle and that if the economy defaults broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year,” Powell said at his press conference on Wednesday afternoon. “But the economy has surprised forecasters in many ways since the pandemic and ongoing progress toward our 2% inflation objective is not assured…We are prepared to maintain the current target range for the federal-funds rate for longer if appropriate.”

That’s a shift in a dovish direction since the Fed’s previous meeting in December, but it’s more hawkish than markets had been hoping for. Stock indexes immediately dropped after the FOMC’s statement was published at 2 p.m. Eastern time and continued falling as Powell began speaking half an hour later, while bond yields ticked higher but still finished lower on the day.

Powell pushed back on the likelihood of a March cut, but he didn’t take it off the table entirely. There will be another six weeks of economic data to parse by the next time the FOMC next meets on March 19 and 20, including a pair of monthly jobs and inflation numbers. Still, it will be a high bar, and a March cut isn’t the “base case” scenario.

“I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting to identify March is the time to [lower interest rates],” Powell said on Wednesday.

Traders had been decidedly more optimistic about cuts on the immediate horizon. As of Wednesday morning, interest-rate futures were pricing in slightly higher-than-even odds of a quarter-point decrease in the fed-funds rate at the FOMC’s March meeting—down from around 70% a month ago. After the policy statement and Powell’s press conference, futures pricing implied a roughly 35% chance of a March cut.

The market continued to price in a year-end fed-funds rate target of 3.75% to 4.00%, implying 1.5 percentage points of reductions this year. Those may just come later in 2024.

“The start of this adjustment might be delayed by a month or two, but we are confident in the direction of travel,” said Paul Mielczarski, head of global macro strategy at Brandywine Global, on Wednesday.

Powell noted the progress already made on reducing the rate of inflation, pointing to six months of “good inflation data.” But he said that officials need to see that continue for some time longer before they are convinced that it’s a sustainable path back to the Fed’s 2% annual inflation goal. When asked just how long officials need, Powell demurred.

“The lower inflation readings over the second half of last year are welcome,” Powell said. “But we will need to see continuing evidence to build confidence that inflation is moving down sustainably toward our goal.”

Adjustments to the Fed’s ongoing balance-sheet reduction may be a bigger topic of conversation going into the March FOMC meeting, with rate cuts seemingly deferred until May, at the earliest. Powell said that the committee will discuss how and whether to begin tapering quantitative tightening, noting that a decision there would be independent from one on changing interest rates.

“Data dependency” remains the name of the game. Officials left themselves maximum flexibility on when to begin lowering interest rates in 2024. With March seemingly off the table, all eyes are now on the May FOMC meeting.

Write to Nicholas Jasinski at [email protected]