Strong US growth looks set to bolster the conviction of Federal Reserve officials that they can afford to take their time on 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 a 23-year high of 5.25-5.5 per cent at Wednesday’s vote on monetary policy. With the decision in little doubt, the big question is to what degree Powell will hint at cuts in the months to come.
Around 50 per cent of investors are still pricing in a move at the next-but-one policy vote. But many economists think the Fed will stand pat until late spring or early summer.
Those betting on a cut later in the year point to the health of the US economy as one of the reasons why rate-setters can avoid the risk of prematurely calling time on the worst spell of price pressures for a generation — only to see inflation then bounce back.
Gross domestic product grew at an annualised rate of 3.3 per cent during the fourth quarter — a strong finish to a year that many economists thought would mark a fall into recession for the US economy. Instead, growth was 3.1 per cent for the year as a whole — the best performance of any major advanced economy.
“There’s just nothing in the data since the start of the year to signal the economy is in danger,” said Krishna Guha, a former Fed official who is now at Evercore ISI. “If you’re a policymaker, you have a tonne of choice on when to go. And starting later plays to this desire to confirm that everything is on track to durably return inflation to 2 per cent.”
The clearest sign of rate-setters’ softly-softly approach came from Christopher Waller earlier this month.
The Fed governor is confident the US central bank is within “striking distance” of hitting its 2 per cent inflation target, after a sharp fall in price pressures over the second half of 2023.
However, strong growth and a tight labour market meant that officials did not have to act fast.
“I see no reason to move as quickly or cut as rapidly as in the past,” Waller said.
Seth Carpenter, an economist at Morgan Stanley who believes the first cut will come in June, thinks that behind some predictions of early cuts lies a belief the US economy could soon tank.
“Some people do still think that there will be a recession in 2024,” Carpenter said. “Others think that inflation is now entirely under control.”
“We expect a soft landing, but we’re not in an entirely different place to markets,” he added. “If we’re wrong on June, I expect it will be because cuts are going to be earlier, not later, than our baseline.”
Fed-watchers think that, barring an economic disaster, rate-setters will want to signal a meeting in advance that cuts are on the way.
“I would expect that, if they’re planning on March, then we would get a pretty clear hint of that from Powell in January,” said Guha, who forecasts May or June as the most likely timing for the first cut.
Some believe that may be tough for Powell to do as soon as next week. They point to a rise in CPI from 3.1 per cent in November to 3.4 per cent last month. However, the measure the Fed is watching most closely, core PCE inflation, fell to an annual rate of 2.9 per cent in December.
The Fed chair could be reluctant to definitively rule out a cut on March 20.
Before that meeting, officials will have two more readings of non-farm payrolls, the key indicator of the health of the US jobs market, as well as a PCE inflation report for January and two CPI prints. They will also be able to look at data revisions that will reveal the degree to which seasonal adjustments affected the rise in CPI inflation in December.
“The flow of data is going to be super important,” Carpenter said.
Also likely to be up for discussion is whether to slow quantitative tightening.
At the moment, the US central bank runs off up to $60bn in US Treasuries and $35bn in other government securities a month. However, the minutes of the December vote noted that some on the committee believe that pace should soon be rethought.
Money market funds’ sharp drop in the usage of a facility to buy and sell Treasuries from the central bank, 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 lessen the chances of spikes in funding costs. Avoiding those spikes would enable the Fed to carry on shrinking its balance sheet uninterrupted for longer.
Nate Wuerffel, a former head of domestic markets at the New York Fed and now at BNY Mellon, said sharp spikes in funding costs during earlier episodes of QT in 2019 would drive officials to make a decision sooner rather than later.
“There’s this notion of slowing and then stopping [the run-off of assets] well in advance of reserves falling from abundant to ample levels,” Wuerffel said. “Policymakers are talking about this because some of them have really deep memories of the 2019 experience and they want to give the banking system time to adjust to lower levels of reserves.”
Wuerffel added: “They know there are limits to what the data can tell us about how money markets are going to behave.”
