FED Monetary Policy

Magaly · December 15, 2023, 3:03pm

Damage control by some of FED members? contradicting what Powell said on Wednesday.
They probably realized it was way too dovish of a message too soon.
I don’t think it will work though. Powell’s speeches always have much more weight.

Federal Reserve Bank of New York President John Williams said it’s too early for officials to begin thinking about cutting rates as soon as March as they consider whether policy is restrictive enough to get inflation back to 2%.

“We aren’t really talking about rate cuts,” Williams said Friday in an interview on CNBC. He noted it’s “premature” to be thinking about cutting interest rates in March.
Fed’s Williams, Bostic Push Back on Interest Rate Cut Talk for Early 2024 - Bloomberg

Historic market reaction after FED meeting across all asset classes:

Aron · January 3, 2024, 8:00pm

I=7

FOMC minutes acknowledged that the rate is likely at or near its peak but signalled that the policy path is uncertain.

“In discussing the policy outlook, participants viewed the policy rate as likely at or near its peak for this tightening cycle, though they noted that the actual policy path will depend on how the economy evolves,” the minutes stated.

“Participants generally stressed the importance of maintaining a careful and data-dependent approach to making monetary policy decisions and reaffirmed that it would be appropriate for policy to remain at a restrictive stance for some time until inflation was clearly moving down sustainably toward the Committee’s objective,” it said.
The minutes pointed out that progress has been made in the fight against inflation and that rate cuts could start at the end of 2024 if the trend continues.

“In their submitted projections, almost all participants indicated that, reflecting the improvements in their inflation outlooks, their baseline projections implied that a lower target range for the federal funds rate would be appropriate by the end of 2024,” the FOMC minutes stated.

Magaly · January 3, 2024, 8:11pm

End of 2024 is definitely not what the markets think

Magaly · January 23, 2024, 8:42pm

Markets are changing the probabilities of a rate cut in march, it is no longer priced in. But still, 6 cuts are expected.

Magaly · January 30, 2024, 8:53pm

Slowing QT by the FED could maybe be closer?

Christopher Waller (FED governor), recently said balance sheet run-off could start to slow when bank reserves get to 10-12% of GDP, this would mean ~2,75 -3.4T reserves, currently at 3.52 T. So not much run away really.
In March 2023, when liquidity issues started in some banks, their reserves were at ~3T, and got as low as 2.83T in January 2023.

“We’ll start slowing as we approach maybe reserves being 10% to 11% of GDP,” Waller said at a Council of Foreign Relations event in New York. “And then we’ll kind of feel our way around to see where we should stop.”

https://www.reuters.com/markets/us/fed-can-likely-slow-runoff-bank-reserves-near-10-11-gdp-2023-01-20/

The complete draining (or getting to a low level) of the reverse repo facility could add to this possibility because banks would need to absorb more treasury supply, draining their reserves again, which have been currently increasing since March 2023.

The FED is also going to the BTFP program created in march 2023 to help banks with liquidity in March 2024.

The FED has not said anything official about reducing QT, so tomorrow’s meeting and the subsequent meeting will be increasingly important to get a signal either way.

For tomorrow’s meeting no cut is expected, and cuts are expected to start now in may 2024, with a total of 5-6 in 2024.

Aron · January 31, 2024, 7:20pm

I=7

The FOMC kept the fed’s target range unchanged at 5.25%-5.50% as was expected by the market.
The statement signalled that they are not ready to cut interest rates yet.

“The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent,” the statement noted.
The committee said that the economic growth has been solid and that progress has been made in the fight against inflation though economic outlook remains uncertain.

"Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have moderated since early last year but remain strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated,"the statement said.

The economic outlook is uncertain, and the Committee remains highly attentive to inflation risks."
The officials dropped their previous statement that suggested they were open to more rate hikes and adopted a fair assessment of the future.

“The Committee judges that the risks to achieving its employment and inflation goals are moving into better balance,” the statement pointed out. “In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.”

Magaly · January 31, 2024, 8:38pm

Powell did push back against rate cuts starting in March because he does not think confidence would be high enough by then.

And while March cuts expectations moved down, the amount of cuts in 2024 does not. I still think 6 cuts are way too much for an economy that is also expected to be good.

He also says they are planning to beging in-depth talks about QT in March, which could mean slowing QT (not stopping) could be closer, as it was signaled before by Waller.

Notes:

They need continuation of the good data of the past 6 months. Confidence is good now, but they need to increase it.
They are not looking for 1 month of inflation at 2%, they would need it to settle at 2% indefinitely. Also not looking to be below it.
As of this meeting, don’t think it’s likely that the committee will reach a high level of confidence by the time of the March meeting to identify March as the time to cut, but that’s to be seen
About the pace of QT, they are planning to begin in-depth discussions of Balance Sheet at the next meeting in March
Softening data has not been needed until now. Don’t look at as strong GDP as a big problem.
The greater risk currently is that inflation stabilized at a level above 3%, the risk of inflation increasing again would be a surprise.
They are in risk management mode now, not moving too soon or too late. The neutral rate is uncertain currently.
The labor market is rebalancing, due to better participation rate and immigration increasing, but still not totally back to normal
If an unexpected weakening of the labor markets happens, that would mean cuts sooner. But they are not looking for that.
He would not say the US has achieved a soft landing, their is still ways to go to declare victory
Powell dont see a big boost in productivity after coming out totally of the pandemic effects, and thinks will come back to previous levels. He does not think AI will have that much of an impact short term.
A lot of the improvement until now has been supply chains normalizing, at some point this will stop having a significant effect

These are the changes in the new statement:

moritz · February 1, 2024, 7:26am

What is your assessment of the meeting?

Without being deeply involved with the topic it appears to me that changing both the language in the statement from „additional firming“ to „any adjustments to the target rate“ and discussing a slow down in QT are significant signs of easing.

Maybe this is the maximum easing they could do without jeopardizing the feds room for maneuver and Powell had to push back against the idea of cuts in march?

Is the meeting fundamentally in line with what the market has been expecting or is it more dovish or hawkish? (Beyond the initial 2h trading reaction. So do we expect prices to remain stable or see e.g. a significant sell offs in the coming days)
What are market commentators that we are following saying about it?

Magaly · February 1, 2024, 1:38pm

The change in the statement and the slowing of QT is easing the market already expected in the most part, and was reflected in market pricing, including yields. That’s why the reaction was pretty much muted with those.

And a certain amount of easing is expected and needed as inflation comes down, if not they will be late and overtigh as real rates increase.

The meeting was actually more hawkish because Powell tried to push back a bit against the expectation that cuts will start as soon as march. The markets sell off yesterday after he made this statement.
But I am not sure if this is because they want to keep options open, or if indeed they will not cut in march, probably economic data will dictate that.

I don’t expect a huge sell off currently, because I think markets will continue to look for signs in any economic data that the FED will have to cut very soon, and a lot of times.

However I think expectations are extremely high and at some point will have to change. Not that I think it will not happen, just that if you get that many cuts that fast (basically 1 per meeting) is because the economy is not in a good place, and if the economy is in a good place you will not get that many cuts. At least I think there will be a lot of volatility around this.

And even if you get 5/6 cuts, and rates come down to ~4%, is still significantly higher than all the maturing debt coming (including the govt), so I don’t think everything will be safe and ok with those cuts as everyone is celebrating, is just less damage. If the FED cuts aggressively and do QE again, that’s another history, they probably only do this in a panic event.

Magaly · February 1, 2024, 5:09pm

Some commentary:

Former Fed Vice Chairman Roger Ferguson

Powell introduced the risk of inflation stopping getting better, settling at a level above target, while the economy is still strong. He thinks is unlikely (0:45)
FED thinks they need/can wait because the economy is still not giving signs of being on edge. (2:34)
NYCB’s situation is a reminder that there is still weakness in some banks, and the FED removing the sound and resilient part from their statement could be a recognition of things they might be hearing from some banks. (4:00)
https://www.youtube.com/watch?v=-HAU7I69hfs

William Dudley, former president of Federal Reserve Bank of New York

Because the economy is still strong and the easing of financial conditions the FED is less inclined to cut rates than would be otherwise. (1:51:00)
QT could probably start on 1H2024. QT is not so much about easing policy, but about getting to the optimal level of bank reserves (1:52:00, 1:55:00)
March is not completely off the table, Powell just said currently seems unlikely. But economic data could dictate otherwise. (1:53:15)
He thinks FED is not that worried about issues in the banking system currently, since there is more transparency to what is happening. (1:56:00)
https://www.youtube.com/watch?v=eXjSPmXH5Ss&t=7084s

Former Kansas City Fed President Esther George

Conference was pushed back against expectation, and the fact the FED will only move when confidence is higher (0:30)
While 6-month data looks good, the committed has a long horizon and focus on the 12-month rate too, but thinks 1H2024 will be a good opportunity to start cutting (1:30)
Risks need to be more balanced now, since we are also starting to hear some credit stress in some parts of the economy (CRE). Which is the expected effects of monetary policy. (4:20)
https://www.youtube.com/watch?v=IfQD9mrBaS4

Aron · February 5, 2024, 2:51pm

I=8

In an interview with 60 Minutes on Sunday, Powell reiterated that it’s unlikely that they will start to cut interest rates in March.

“We have a strong economy. Growth is going on at a solid pace. The labor market is strong: 3.7% unemployment. And inflation is coming down. With the economy strong like that, we feel like we can approach the question of when to begin to reduce interest rates carefully,” he said.

“We want to see more evidence that inflation is moving sustainably down to 2%. We have some confidence in that. Our confidence is rising. We just want some more confidence before we take that very important step of beginning to cut interest rates,” Powell added.
Powell pointed out that they want to see more good data before the can cut the rates.

“Basically, we want to see more good data. It’s not that the data aren’t good enough. It’s that there’s really six months of data. We just want to see more good data along those lines. It doesn’t need to be better than what we’ve seen, or even as good. It just needs to be good. And so, we do expect to see that. And that’s why almost every single person on the, on the Federal Open Market Committee believes that it will be appropriate for us to reduce interest rates this year.”

https://www.bloomberg.com/news/articles/2024-02-05/read-the-full-transcript-of-powell-s-interview-with-cbs-s-60-minutes

Magaly · February 5, 2024, 6:30pm

I think the FED is just worried about cutting rates, just to have to increase them again later on.
They would probably be embarrassed if this happened to them. Especially since the huge failure in 2021 with their inflation reaction.

Is a valid worry since that’s what happened in the 70-80’s. And current macro growth is picking up in some areas.

But also being worried about this long enough could make them late once again to react. If they wait until the labor market gets very weak, it will be already too late to react too. Is a tricky balance for them currently, I would not want their job never.

Magaly · February 8, 2024, 7:23pm

For those who are expecting ~150 or more, there is no justification other than if they think the economy will be horrible this year.

https://twitter.com/NickTimiraos/status/1755668213143072872/photo/1

Magaly · February 16, 2024, 4:57pm

I am not his fan, but his thinking is not wrong.
I also think is a low probability currently for more rate hikes, but it would be a result that would take almost everyone by surprise.

Some other analysts that I follow closely, like Jim Bianco and to extent Lyn Alden (Lyn’s thesis is more of a 1940s scenario), have had this thesis since last year.
And tbh, data as of today supports more of these than everyone else’s, including mine, but it’s still early IMO.

In short summary this is what their thesis support:

Jim Bianco

He has been making the argument the economy instead of going into recession is going to remain strong, with inflation already bottoming and remaining sticky at higher levels.

He thinks there was a secular change in the economy, and inflation after COVID, and that current rates are actually not that restrictive, because neutral rates seem to be higher now.

Lyn Alden

Lyn’s thesis is different, she thinks rate hikes, but mostly increasing fiscal deficits will be contributing to inflation because they are very stimulative to the economy. But the FED unfortunately currently only has that tool to fight it.
Ultimately she thinks another wave of inflation could happen, the nominal economy will run hotter than expected, and US economy will be in some sort of fiscal dominance.

Either way, data coming like this, will maybe play into the FED physique that I am sure is probably very fearful that another 70-80’s will happen to them too.

Which at the same time could lead to the mistake of waiting too long to cut rates as necessary, and cause a severe contraction or shock.
They also have the risk that if they cut rates could lead to an overheating of the economy and inflation again, additional hikes would be necessary after that.
As I always say I would not want their job currently because data is giving all the mixed signals, even from 1 month to another.

Magaly · February 21, 2024, 9:12pm

The most important part of the minutes today is again about the possibility of slowing QT soon/.

FED warned RRP depletion will be negative to bank reserves, as I noted and explained here before.

The staff also noted that once the ON RRP facility is either depleted or stabilized at a low level, reserves will decline at a pace comparable with the runoff of the Federal Reserve’s securities portfolio, all else equal.

But they will try to offset that negative effect by slowing the pace of QT, so an announcement in March or May about this is very likely. However, slowing QT could just mean being able to keep QT for longer.

In light of ongoing reductions in usage of the ON RRP facility, many participants suggested that it would be appropriate to begin in-depth discussions of balance sheet issues at the Committee’s next meeting to guide an eventual decision to slow the pace of runoff.

Some participants remarked that, given the uncertainty surrounding estimates of the ample level of reserves, slowing the pace of runoff could help smooth the transition to that level of reserves or could allow the Committee to continue balance sheet runoff for longer.

In addition, a few participants noted that the process of balance sheet runoff
could continue for some time even after the Committee begins to reduce the target range for the federal funds rate.

About rate cuts, they are currently more concerned about cutting too quickly than waiting too long, probably due to potential upside risks on inflation.

Most participants noted the risks of moving too quickly to ease the stance of policy and emphasized the importance of carefully assessing incoming data in judging whether inflation is moving down sustainably to 2 percent. A couple of participants, however, pointed to downside risks to the economy associated with maintaining an overly restrictive stance for too long

Several participants mentioned the risk that financial conditions were or could become less restrictive than appropriate, which could add undue momentum to aggregate demand and cause progress on inflation to stall.

Magaly · February 27, 2024, 9:41pm

Huge shift in rate cuts expectations in just a matter of weeks.

And while equities had a huge rally after November when rate expectations started to increase, is as if they don’t even care currently those cuts are now priced out mostly.
I do not know yet if there is a threshold in yields where the reaction could be triggered.

Aron · March 6, 2024, 1:56pm

I=6

Powell reiterated that they are not ready to start cutting interest rates soon.

" In considering any adjustments to the target range for the policy rate, we will carefully assess the incoming data, the evolving outlook, and the balance of risks,“he said in prepared remarks for appearances on Capitol Hill. The Committee does not expect that it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”
However, he said they remain concerned about not losing the progress they have made in the fight against inflation and that it may be possible to start cutting rates this year.

“We believe that our policy rate is likely at its peak for this tightening cycle. If the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year. But the economic outlook is uncertain, and ongoing progress toward our 2 percent inflation objective is not assured. Reducing policy restraint too soon or too much could result in a reversal of progress we have seen in inflation and ultimately require even tighter policy to get inflation back to 2 percent,” he said.
Powell also pointed out that inflation has eased substantially without causing adverse effects to the economy or labor markets.

“While inflation remains above the Federal Open Market Committee’s (FOMC) objective of 2 percent, it has eased substantially, and the slowing in inflation has occurred without a significant increase in unemployment. As labor market tightness has eased and progress on inflation has continued, the risks to achieving our employment and inflation goals have been moving into better balance.”

Magaly · March 15, 2024, 4:54pm

Markets continue to price out their rate cut expectations for 2024, now it is barely 3 cuts for 2024. And June is about to get below 50% too due to lately inflation readings coming hotter than expected.

I always thought it would make no sense to have significant cuts if the economy and inflation continued to perform as they are doing. And think more cuts could continue to be priced out or at least pushed to later on if data continues to come hotter, absent any significant shock to the economy.
What Powell decides to signal next week is going to have a significant impact too.

Magaly · March 20, 2024, 3:23pm

No changes are expected for today’s meeting. I expect a more hawkish tone in the conference.
We get new projections, and there has been speculation the FED maybe remove at least 1 cut from their forecasts this year, with higher inflation projected too.
No changes to QT yet, but maybe they will announce more details about when and how they will start to slow it down.

This is a useful table I found, I will think about creating my own for next meetings or updates. I would probably create it better, with 6-month or 3-month ann rates and more data, but is still useful to see that data has come out hotter than not since the last meeting.
Interesting to think about the divergence between labor and inflation data, which if it continues, will put the FED in a very difficult situation.

Aron · March 20, 2024, 6:04pm

I=7

The fed kept its target range for the federal funds rate steady at 5.25%-5.50%, as expected.
They still expect three quarter percentage point rate cuts this year despite inflation persiting. However, they forecasted one fewer cut in 2025.
They raised their 2024 projections for GDP and core PCE inflation to 2.1% and 2.6% from 1.4% and 2.4%, respectively.
Their post-meeting statement was identical to the one released on January except for a change on its job growth assessment to “strong” from “moderate”.