Strong U.S. growth should reinforce Federal Reserve officials’ belief that they can afford to take their time cutting rates.
Jay Powell and the rest of the voting members of the Federal Open Market Committee will almost certainly leave benchmark interest rates unchanged at their 23-year high, between 5.25 and 5.5 percent, when they vote Wednesday on monetary policy. With the decision in no doubt, the big question is to what extent Powell will hint at cuts in the coming months.
Around 50 percent of investors still anticipate a development in the penultimate political vote. But many economists think the Fed won’t move until late spring or early summer.
Those betting on a decline later in the year cite the health of the U.S. economy as one reason policymakers can avoid the risk of prematurely ending the worst period of price pressures in a century. generation – to then see inflation. bounce.
Gross domestic product grew at an annualized rate of 3.3 percent in the fourth quarter – a strong end to a year that many economists predicted would mark a slide into recession for the U.S. economy. Instead, growth was 3.1 percent for the whole year – the best performance of any major advanced economy.
“There is simply nothing in the year-to-date data that indicates the economy is in danger,” said Krishna Guha, a former Fed official who now works at Evercore ISI. “If you are a policymaker, you have a multitude of choices about when to leave. And starting later responds to this desire to confirm that everything is on track to bring inflation sustainably to 2 percent.”
The clearest sign of rate-setters’ soft-spoken approach came from Christopher Waller earlier this month.
The Fed governor is convinced that the US central bank is within “strike distance” of reaching its 2% inflation target, after a sharp decline in price pressures during the second half of 2023.
However, strong growth and a tight labor market have prevented authorities from acting quickly.
“I don’t see any reason to act as quickly or reduce as quickly as in the past,” Waller said.
Seth Carpenter, an economist at Morgan Stanley, who estimates the first cut will come in June, believes that behind some forecasts of early cuts lies the belief that the US economy could soon collapse.
“Some people still think there will be a recession in 2024,” Carpenter said. “Others believe inflation is now fully under control.”
“We expect a soft landing, but we are not in a totally different situation than the markets,” he added. “If we are wrong in June, I think it will be because the reductions will be made earlier, not later, than our baseline.”
Fed watchers believe that, barring economic disaster, policymakers will need to signal in advance at a meeting that cuts are underway.
“I would expect that if they plan in March, Powell will give us a pretty clear idea in January,” said Guha, who predicts May or June as the most likely time for the first reduction.
Some think it might be difficult for Powell to do so as early as next week. They point to a rise in the CPI from 3.1 percent in November to 3.4 percent last month. However, the measure the Fed watches most closely, core PCE inflation, fell to an annual rate of 2.9 percent in December.
The Fed chairman may be reluctant to definitively rule out a cut on March 20.
Before that meeting, officials will have two more readings of nonfarm payrolls, the key indicator of the health of the U.S. jobs market, as well as a report on PCE inflation for January and two CPI figures. They will also be able to examine data revisions that will reveal how seasonal adjustments affected the rise in CPI inflation in December.
“The flow of data is going to be extremely important,” Carpenter said.
Another topic of discussion will likely be whether to slow down quantitative tightening.
Currently, the US central bank uses up to $60 billion in US Treasury bonds and $35 billion in other government securities each month. However, the minutes of the December vote indicate that some members of the commission believe that this rhythm should soon be rethought.
The sharp decline in money market funds in the use of a central bank treasury bill buying and selling facility, known as overnight reverse repurchase agreements – or ON RRP – could mark the beginning of the end of a period of abundant liquidity, they said.
Since then, Lorie Logan, president of the Dallas Fed and former head of the New York Fed’s markets team, has noted that slowing the pace of QT could reduce the risks of rising funding costs. Avoiding these peaks would allow the Fed to continue reducing its balance sheet uninterrupted and for longer.
Nate Wuerffel, former head of domestic markets at the New York Fed and now at BNY Mellon, said sharp increases in funding costs during QT’s early episodes in 2019 would push officials to make a decision sooner rather than later.
“There is this notion of slowing and then stopping (the flow of assets) well before reserves go from an abundant level to a sufficient level,” Wuerffel said. “Policymakers are talking about it because some of them have very deep memories of the 2019 experience and want to give the banking system time to adjust to lower reserve levels.”
Wuerffel added: “They know there are limits to what the data can tell us about how money markets will behave. »