Faced with stubborn inflation that has raised concerns about where policy is headed, the Federal Reserve has been ensnared in a holding pattern that likely will be reflected when it closes its meeting Wednesday.
Markets are anticipating a near-zero chance that the Federal Open Market Committee, the central bank’s policy-setting arm, will announce any change to interest rates. That will keep the Fed’s key overnight borrowing rate in a range targeted between 5.25%-5.5% for what could be months — or even longer.
Recent commentary from policymakers and on Wall Street indicates there’s not much else the committee can do at this point.
“Pretty much everybody on the FOMC is talking from the same script right now,” said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott. “With maybe one or two exceptions, policymakers pretty universally agree that the last few months of inflation data are too warm to justify action in the near term. But they’re still hopeful that they will be in a position to cut rates later.”
The only piece of news likely to come out of the meeting itself is an announcement that the Fed soon will reduce the level at which it is running down the bond holdings on its balance sheet before bringing an end to a process known as “quantitative tightening” altogether.
Outside of that, the focus will be on rates and the central bank’s unwillingness to budge for now.
Lack of confidence
Officials from Chair Jerome Powell on down through the regional Fed bank presidents have said they don’t expect to start cutting rates until they get more confidence that inflation is headed in the right direction and back to the 2% annual goal.
Powell surprised markets two weeks ago with tough talk on how committed he and his colleagues are to achieve that mandate.
“We’ve said at the FOMC that we’ll need greater confidence that inflation is moving sustainably towards 2% before [it will be] appropriate to ease policy,” he said at a central bank conference. “The recent data have clearly not given us greater confidence and instead indicate that it’s likely to take longer than expected to achieve that confidence.”
Markets actually have held up pretty well since Powell made those comments on April 16, though stocks sold off Tuesday ahead of the meeting. The Dow Jones Industrial Average had even gained 1% during the time as the market has sought to live with the prospect of a higher-for-longer rate climate.
But there’s always the specter that an unknown could come up.
That likely won’t happen during the business portion of the FOMC meeting, as most observers think the committee statement will show little or no change from March. Yet Powell has been known to surprise markets in the past, and his comments at the press conference will be scrutinized for just how hawkish of a view committee members hold.
“I doubt we’re going to get something that really surprises market pricing,” LeBas said. Powell’s comments “were pretty clear that we have not yet reached the threshold for significant further evidence of cooling inflation.”
There’s been plenty of data lately to back up that position.
The personal consumption expenditures price index released last week showed inflation running at a 2.7% annual rate when including all items, or 2.8% for the all-important core measure that excludes food and energy. Fed officials prefer the Commerce Department index as a better inflation measure and focus more on core as a better indicator of long-term trends.
Additional evidence came Tuesday when the Labor Department said its employment cost index rose 1.2% in the first quarter, a 0.3 percentage point gain from the previous period and ahead of the Wall Street outlook for 1%.
None of those numbers are consistent with the Fed’s goal and likely will push Powell to exercise caution about where policy goes from here, with an emphasis on the fading outlook for rate cuts anytime soon.
Down to one cut, hopes for more
Futures market pricing sees only about a 50% chance of a rate cut as early as September and is now anticipating just one quarter-percentage-point reduction by the end of 2024, according to the CME Group’s much-viewed FedWatch measure.
Some on Wall Street, though, are still hopeful that inflation data will show progress and allow the Fed to cut.
“While the recent upside 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, though even moderate upside surprises could delay cuts further,” Goldman Sachs economist David Mericle said in a note.
The Wall Street bank’s economists are preparing for the possibility that the Fed could be on hold for longer, particularly if inflation continues to surprise to the upside. In addition, they said the prospect of higher tariffs following the presidential election — favored by former President Donald Trump, the Republican nominee — could be inflationary.
On top of that, Goldman is part of a growing chorus on the Street that thinks the Fed’s March projection for the long-run “neutral” interest rate — neither stimulative nor restrictive — is too low at 2.6%.
However, the firm also doesn’t see rate hikes coming.
“We continue to think that rate hikes are quite unlikely because there are no signs of genuine reheating at the moment, and the funds rate is already quite elevated,” Mericle said. “It would probably take either a serious global supply shock or very inflationary policy shocks for rate hikes to become realistic again.”
Unwinding QT
One bit of news the Fed likely will make at the meeting would be an announcement regarding the balance sheet.
The Fed has been allowing up to $95 billion in maturing Treasurys and mortgage-backed securities to roll off each month, rather than reinvesting the proceeds. The operation has reduced the Fed’s total holdings by about $1.5 trillion.
Officials at their March 19-20 meeting discussed cutting the amount of run-off “by roughly half from the recent pace,” according to minutes from the session.
As the Fed reduces its holdings, bank reserves parked at the Fed theoretically would decline as institutions put their money elsewhere. However, a dearth of Treasury bill issuance this year has caused the reserves level to rise by about $500 billion since the beginning of the year to $3.3 trillion as banks park their money with the Fed. If the reserves level doesn’t drop, it might push the Fed into carrying out QT for longer.
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