Federal Reserve Chairman Jerome Powell attends a press conference in Washington, DC on December 13, 2023.
Liu Jie | Xinhua News Agency | Getty Images
Immediately after the Federal Reserve wraps up its meeting this week, all eyes will likely be on a little wording that could reveal the future of monetary policy.
In its post-meeting statement, the central bank is expected to give a major indication of impending interest rate moves by removing a clause from previous statements that reads: “In determining the extent of additional policy tightening that may be appropriate to address inflation “2 percent over time,” followed by a description of the conditions assessed.
For more than a year, the language has underscored the Fed’s willingness to raise interest rates until it reaches its inflation target. Remove this clause and it opens the door to possible future rate cuts; Keep it that way, and policymakers will send a signal that they’re not sure what to expect.
The difference will be of great importance for the financial markets.
A change in wording could amount to a “significant revision” of the Federal Open Market Committee’s post-meeting statement and direction, according to economists at Deutsche Bank.
“At the December meeting we heard that no official expected to raise interest rates further as a baseline outcome. And we’ve heard that Fed officials are starting to discuss rate cuts,” Matthew Luzzetti, Deutsche Bank’s chief U.S. economist, said in an interview. “So removing that explicit tightening bias is kind of a prerequisite for thinking more actively about when rates might be cut and keeping the door open for a rate cut in March.”
While the market has accepted for months that the Fed will probably be done raising rates, the most burning question is when it will start cutting rates. The Fed last raised interest rates in July 2023. Since then, inflation numbers have fallen and are in some ways less than a percentage point away from the central bank’s 12-month target of 2%.
Just a few weeks ago, futures markets were confident that the Fed would begin trading in March, giving such a move a nearly 90% probability, according to CME Group’s FedWatch indicator. There is significantly more uncertainty now, as several statements from Fed officials point to a more cautious approach to declaring victory over inflation.
Reading the tea leaves
Chairman Jerome Powell will have a fine line to walk at his post-meeting press conference.
“You will get a lot of data between the January and March meetings, particularly on inflation,” Luzzetti said. “How this data is received will be crucial to the outcomes of future meetings. He will leave it open, but will not try to open it any further than the market already has.”
At this meeting it will be more difficult to see the direction of the entire FOMC because it will not contain the quarterly “dot plot” of individual members’ forecasts.
However, most public statements made by officials in recent days suggest that there is no rush to implement austerity measures. At the same time, policymakers have expressed concern about too much tightening.
The key interest rate, which is currently targeted at a range between 5.25% and 5.5%, is restrictive by historical standards and appears to be becoming more restrictive the more inflation falls and the “real” interest rate rises. The inflation rate, as measured by core personal consumption expenditure prices, a U.S. Commerce Department measure preferred by the Fed, suggests that the real federal funds rate is about 2.4%. Fed officials expect the long-term real interest rate to be closer to 0.5%.
“The most important thing they probably want to do is gain a lot of freedom of choice,” said Bill English, a former head of the Fed’s monetary division and now a finance professor at the Yale School of Management. “That would mean saying something pretty vague at this point.” [such as] We determine the political position that might be appropriate, or something like that.”
Preparing for the future
In post-meeting statements dating back to at least the end of 2022, the phrase “in determining the extent of additional monetary tightening” or similar language was used to convey the FOMC’s determination to tighten monetary policy to control inflation to lower.
With six- and three-month readings showing that inflation is actually at or below the 2 percent target, such a hawkish stance may now seem unnecessary.
“What that actually means is that they are more likely to increase than to decrease,” English said of the clause. “I guess they don’t think that’s really true. So I think they want to be ready to cut rates in March if it seems appropriate when they get there.”
Officials will weigh falling inflation against stronger-than-expected economic growth. Gross domestic product grew at an annual rate of 3.3% in the fourth quarter, lower than the previous period but well above what Fed officials had expected at the time.
According to CME Group’s FedWatch Indicator, traders in the Fed funds futures market expect a roughly 60% chance of a cut in March, the first of five or six moves through the end of 2024, with gains around a quarter of a percentage point can be assumed. FOMC members indicated in their latest forecasts in December that there would only be three reductions this year.
The Fed hasn’t cut as aggressively since the 1980s as traders expected without a recession, and that “led to investor overconfidence that culminated in the stock market crash of 1987,” Nicholas Colas, co-founder of DataTrek Research, said in his daily market quote Monday evening.
Nevertheless, economists at Goldman Sachs assume that the Fed will “abandon the now outdated tendency to raise interest rates” and set the course for a rate cut in March and a total of five rate cuts over the course of the year. In a note to clients, the company also said it also expects the committee could adopt a line from the December meeting minutes that said it would be “appropriate for policymakers to maintain a restrictive stance until the “Inflation is clearly moving towards the committee’s goal in a sustainable manner.”
However, a restrictive stance is not the same as maintaining interest rates at current levels and such a language move would give the Committee scope for reductions.
Markets will also be looking for information on when the Fed will begin reversing its balance sheet reduction, a process that has seen the central bank reduce its bond holdings by about $1.2 trillion since mid-2022.
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2024-01-30 21:34:59
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