The Fed stayed camped at terminal for a sixth consecutive meeting on Wednesday, as expected.
May’s “decision” was no decision at all. Traders long ago gave up on a rate cut before the June SEP meeting. By now, June’s out too. Indeed, markets this week faded all but one of what, as of mid-January, were more than six cuts priced into the forward curve.
Just as this week’s policy deliberations began, an overshoot on the Employment Cost Index found 2024 rate-cut pricing trimmed inside of 30bps, nearly two full quarter-point reductions fewer than the trajectory conveyed by the median 2024 marker in the March dot plot.
It’d take consecutive negative NFP prints to keep the 2024 dot unchanged next month. Barring an abrupt deterioration in the labor market (which isn’t forthcoming), next month’s SEP refresh will surely see this year’s marker shift up by 25bps and maybe by 50bps.
The May statement retained most of the March language to describe the economy. Job gains are “strong,” the unemployment rate’s “low” and inflation’s “elevated.”
The Committee added an overtly hawkish line referencing a succession of early-year CPI overshoots. “In recent months, there has been a lack of further progress toward the Committee’s 2% inflation objective,” the statement sighed.
With that rather blunt assessment on the record, the forward guidance was left unchanged. The Committee “does not expect it will be appropriate” to cut rates “until it has gained greater confidence that inflation is moving sustainably toward 2%.” In other words: Recent data has not increased the Fed’s level of confidence.
To reiterate: A cut next month’s out of the question unless something very, very bad happens between now and June 12.
July’s theoretically still in play for the first cut, but my guess is that Jerome Powell’s parked at the peak until September.
The Fed also sketched the contours of the QT taper on Wednesday. The parameters and timeline were largely as expected. The MBS caps won’t change, but the pace of Treasury runoff will slow sharply (more than consensus, in fact).
Beginning in June, the redemption cap on Treasurys will drop from $60 billion to $25 billion. That was $5 billion more (i.e., lower) than expected. MBS proceeds beyond the cap will be reinvested in Treasurys.
If the Committee wants to shorten WAM (in keeping with recent comments from Chris Waller and nods in that direction from Powell) any diverted MBS reinvestments could target bills.
Whatever the plan is in that regard, the “here and now” read-through for bonds from the lower Treasury runoff cap and the diversion of MBS reinvestments (the latter’s obviously irrelevant if MBS redemptions don’t exceed the caps) is bullish and could offset the hawkish rates guidance.
And with that, all eyes turned to Powell’s press conference.
Powell wants to cut so bad
With FOMC frozen between unreadiness to cut and unwillingness to hike, seems Fed may recede as a market factor for a time. Since the Fed often has a counter-cyclical lean, could imply more market volatility around economic data. To a point – presumably the Powell Put is still there should economic data weaken alarmingly.
Are we just witnessing the flip side of passive tightening? If Fed is holding terminal in the face of higher inflation while it also slows the pace of QT, that is passive loosening and yet everyone remains laser focused on the FF target range. Haven’t we essentially already gotten our first quarter point “cut”?
Federal budget deficit is expected to increase in 2025 ($1.8T) over 2024 ($1.6T) per the CBO. In 2025, this means the deficit will exceed 6.1% of GDP.
I still believe it matters what the deficit is spent on. There are good and bad deficits because some spending has a better chance of providing a long term benefit for the US than other types of spending. However, if deficit spending in 2025 is in similar categories to what it is in 2024- it is hard to believe there will be any interest rate cut(s).