FED Monetary Policy

[Magaly]

So the FED revised growth and core inflation significantly higher, but kept rates expected unchanged for 2024. Fairly dovish for the market’s momentum to continue this year.

However, they increased projected fed funds for 2025 and 2026, and most importantly they raised the neutral rate (long run) that has been unchanged for long, with many more officials now above 2.5%, and 7 officials above a neutral rate above 3% from 4 in the last dot plot.

I agree with most analysts is difficult to make sense of the 2024 projections, but I think something that Mohamed said could be interesting:

The way to make sense of these projections is if the FED is accepting or tolerating higher inflation than the target for longer to be able to achieve a soft landing or maintain economic well-being.

IMO this could be playing with their credibility again, especially if it happens that inflation indeed increases again.
But FED projections are only the median of 19 forecasts and not really a collective forecast, but markets usually take it as such. Powell also did not have the best conference.

Notes from Powell:

• Powell was not able to give a good answer when asked if they are willing to tolerate higher inflation due to their projections. Only said growth and inflation were revised due to recent data, but did not say anything why rates were then unchanged for 2024.
• They continue to see risks more balanced now between unemployment and inflation.
• Dont think the history that inflation is coming gradually down to 2% has changed from the last 2 months’ inflation hotter data, it just signals the route could more “bumpy”. However, they still don’t know if these two months were only a bump, or if its something more. (So, basically they don’t know anything)
• He dont see rates coming back down to the very low levels seem before COVID, but he thinks it is still highly uncertain to know for sure when the neutral rate will settle
• The confidence to ease will be dependent on incoming data. Base effects from last year are low, so it could be it takes longer.
• They still see a very strong labor market, and dont see any of the cracks analysts sometimes mention.
• According to Powell, QT tapering could be coming fairly soon. Their view is that this could allow them to keep QT for longer, so not necessarily that dovish.
  The banking system’s liquidity health and reserves will play a significant role in this, they want to slow QT to avoid a liquidity event.

[moritz]

Interesting meeting and a good summary of events.

The strong increase in GDP growth projections especially stands out to me, while core inflation increases look moderate.

Based on the history of neutral longer-term rate projections from your second picture, the increase in FOMC Dotcs median appears to be relatively small, about 10bp. Is this something people are talking about? Do you have a take on the practical relevance of those projections and do you think it is influencing policy decisions as of now?

I am very interested in any details of QT. Did they give any insights on how much they might slow down the pace of it? I think that element might be what is moving markets like crypto the most.

A table like the one you found in your post above, which brings all data points together, is certainly good to help readers get an overview. I think, as you say, it’s important to take an average on some volatile data points and also, importantly, to weigh the importance of the insights in order to focus the reader on important signals and help deemphasize noisy or irrelevant data points.

[Magaly]

The increase in the neutral rate is not about the size of the increase yet, is more the fact that they finally did it, and that it could continue (signaling low levels as before is probably not appropriate anymore). The 2.6 is just the median, but the dot plot is showing more and more officials are starting to increase their neutral rate, some even above 3%, it would just take more of them continuing to do it to continue to increase.

And there has been a lot of speculation from analysts that the neutral rate will be higher now, some even saying ~4%, so this is just confirmation it could be indeed the case in the future. Powell said they still don’t know where it will settle, but that low levels of rates as before is probably not happening.

But I don’t think we know. I mean, my instinct would be that rates will not go back down to the very low levels that we saw where all around the world there were long-run rates that were at or below zero in some cases. I don’t see rates going back down to that level. But I think there’s tremendous uncertainty around that.

The projections as you know I think are useless and not even the FED will follow them. They have continued to say again and again that they are data-dependent, so incoming data will be much more important to influence decisions.

But the markets always react to them if there are significant changes that are not expected, so is important to understand them from the market perspective to know what they are pricing. Yesterday in the commentary the majority of the focus was on the fact that they revised growth and inflation up but kept rates unchanged for 2024. Giving this feeling to the markets that even if inflation and growth increased a bit, they are still going to cut the same, which is pretty bullish if you take it like that, especially a market that only cares about cuts and liquidity.

And, there aren’t new details about QT, only that it will come soon. I don’t think QT news is necessarily what is responsible for the majority of the move, since this is something that has been already known since the last meeting.
I also do not see this as that positive, they will only want to slow it down to offset the negative effect that the draining of the Reverse Repo is going to have on bank reserves. So, it is not necessarily adding more liquidity.

what we’re really looking at is slowing the pace of runoff. There isn’t much runoff among MBS right now, but there is in Treasurys. And we’re talking about going to a lower pace. I don’t want to give you a specific number because we haven’t made a—haven’t had an agreement or a decision. But that’s the idea. And that’s what we’re looking at.

The point of that table is that all the data included will be important for their category (not talking about the one I shared), there is no point in including something to be dismissed by the reader, but it can be sorted at least for relevance. But as you know I don’t think economic data should be looked like that either, and I would not want to imply or teach anyone that they should only focus on certain data to form an assessment.

[Magaly]

Current expected rates from major institutions.
I think some of these analysts are clueless tbh, they have been changing these expectations all over the place. So there is minor confidence I have in their forecasting abilities.
And the expectations some had at the beginning of the year were not even realistic (with 6 on average) because of how the economy and inflation was behaving back then (absent any shock as always).

[Aron]

I=6

• Powell reiterated that it will take a while for them to evaluate the current state of inflation.

  “On inflation, it is too soon to say whether the recent readings represent more than just a bump,” Powell said in prepared remarks ahead of a question and answer session at the Stanford University.

  “We do not expect that it will be appropriate to lower our policy rate until we have greater confidence that inflation is moving sustainably down toward 2 percent,” he added. “Given the strength of the economy and progress on inflation so far, we have time to let the incoming data guide our decisions on policy.”

• He pointed out that recent data have not changed the overall picture that inflation is cooling.

  “The recent data do not, however, materially change the overall picture, which continues to be one of solid growth, a strong but rebalancing labor market, and inflation moving down toward 2 percent on a sometimes bumpy path.”

Speech by Chair Powell on the economic outlook - Federal Reserve Board.

[Magaly]

Powell is very focused on the supply side now.

Most of his responses were focused on the fact the supply chain issues improving seem to have been the force behind the performance of the economy last year, along the decline in inflation until now.

He points to immigration being a big driver of supply improvement in the labor market.
To which I pointed last month it was indeed surprising to me that most net jobs in the US have gone to foreigners since 2018, but especially since 2020.

However, he says he is not sure how much improvement we can get from supply going forward, and how much of this will have to fall instead under demand constraints. The problem is, that demand and spending are still very high.

Fed Chair Powell delivers remarks on the economic outlook at Stanford Business School — 4/3/24

[Magaly]

Today FED minutes gave more details about QT.

• Committee’s slowing of balance sheet runoff would begin slightly later than previously expected, with the majority of survey participants now expecting the slowing to start around midyear
• In their discussions regarding how to adjust the pace of runoff, participants generally favored reducing the monthly pace of runoff by roughly half from the recent overall pace.
• Participants generally preferred to maintain the existing cap on agency MBS and adjust the redemption cap on U.S. Treasury securities to slow the pace of balance sheet runoff.
• The decision to slow the pace of runoff does not mean that the balance sheet will ultimately shrink by less than it would otherwise.
  https://www.federalreserve.gov/monetarypolicy/files/fomcminutes20240320.pdf

[Aron]

I=8

• Powell said firm inflation this year has introduced uncertainty over when they will cut interest rates.

  “More recent data shows solid growth and continued strength in the labor market, but also a lack of further progress so far this year on returning to our 2% inflation goal,”he said during a forum on U.S.-Canada economic relations.

  “The recent data have clearly not given us greater confidence, and instead indicate that it’s likely to take longer than expected to achieve that confidence,” he said. “That said, we think policy is well positioned to handle the risks that we face.”

• He pointed out that they can maintain the current policy rate until they make progress in the fight against inflation.

  “We can maintain the current level of restriction for as long as needed.”

Fed Chair Powell says there has been a 'lack of progress' this year on inflation

[Magaly]

Tomorrow we have the FED meeting. This is where expectations stand as of today for rates, 2 rate cuts starting in September/November.

Currently, it’s unclear whether the economy needs any rate cuts this year, even 2 cuts appear like too much to me given the latest data. However, this assessment remains subject to change with new developments, particularly following the release of the GDP report, which has increased the uncertainty. There is still a lot of time between now and the end of the year, but I am still unsure what would be the FED reaction in a stagflation scenario, especially if the labor market also shows more weakness.

Prior expectations

As a disclaimer, I’ve lost all confidence in their ability to foresee this accurately. Market participants have shown a lot of inconsistency throughout the year with this. When they were anticipating an average of 6/7 cuts starting in March, I always expressed skepticism regarding their expectations, as they seemed very detached from reality. It seemed as if they were pricing in their desired outcomes rather than reflecting reality, especially considering there were signs of reacceleration since the beginning of the year in some areas.
Hence, these expectations are only useful to me to gather their current pricing, allowing us to calculate potential changes based on new developments and anticipate market reactions.

[moritz]

Yeah, these inaccuracies highlight the need and value of our own proprietary research.

Expectations have been consistently wrong. I would say the failure to predict how high rates would go in 2022 was worse (and even caused the collapse of some companies like SVB) but the latest discrepancy is also interesting.

[Aron]

I=8

• Fed leaves its target range for the federal funds rate unchanged at 5.25%-5.50%, as expected.

• Its post-meeting statement notes lack of further progress in the fight against inflation in recent months.

  “Inflation has eased over the past year but remains elevated. In recent months, there has been a lack of further progress toward the Committee’s 2 percent inflation objective.”

• The committee reiterated that they don’t have enough confidence at the moment to reduce the target range.

  “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 committee voted to ease the pace at which they allow maturing bond proceeds to roll off without reinvesting them, some sign of monetary easing.

  “Beginning in June, the Committee will slow the pace of decline of its securities holdings by reducing the monthly redemption cap on Treasury securities from $60 billion to $25 billion. The Committee will maintain the monthly redemption cap on agency debt and agency mortgage‑backed securities at $35 billion and will reinvest any principal payments in excess of this cap into Treasury securities.”

Federal Reserve issues FOMC statement

[Magaly]

The conference definitely with a dovish tone, leaving the message that despite recent data, their overall plan remains largely unchanged, with only a potentially higher threshold for rate cuts. Market reaction was especially positive when he said that rate hikes are unlikely, alleviating concerns that had begun to appear within the markets about this.

Another surprising development was the (QT) tapering announcement, markets were anticipating a reduction of 30B, but it came in at 25B instead. Either way, this is expected to have a liquidity-positive effect, approximately 420B positive effect annually for the treasury.
I don’t even know if the government needs additional reassurance to continue spending as it does, but they seem more worried about the downside risks.

I’m concerned about the Federal Reserve’s lack of seriousness or hawkishness in response to recent data surprises. Even though a rate cut is still anticipated this year, and a hike seems unlikely, their current tone towards the markets might encourage further financial loosening, which could make their job even more difficult. A more assertive language could serve as an interesting restriction, but instead, they are choosing to do the opposite. Additionally, if inflation continues to surprise to the upside, it will be pretty horrible for their confidence.

I also don’t like their overly data-dependent approach, which may lead to being reactionary only and being late always. The Federal Reserve should be 1 of the best or the best at forecasting and economic outlooks, yet they consistently fail in this, not even themselves can trust and follow their projections, which is not a good look.

Some notes I took:

• From the Q1 2024 data the signal they are taking is that is going to take longer to gain confidence inflation is coming to 2%, signaling a higher bar to cut rates.
• Unlikely next move is a hike. If data supports it in the future they would take that step, but they need evidence and currently, it isn’t there.
• He’s still expecting inflation to come down, in large part because of the shelter disinflation everyone has expected (I am not even so sure about this anymore)
• QT slowing is to avoid any financial accident, and being able to reach the final goal in a more gradual way
• There is evidence the current policy is restrictive, which is noticeable in the labor easing we have seen until now. But if it is sufficiently restrictive only coming data will tell, but they think it is.
• A labor market weakening should be significant to be able to cut. The current increase in the unemployment rate is still not enough.
• Economic activity remains at a similar pace to last year, so to know what’s causing inflation in Q1 2024 only time will tell more clearly.
• Dont like to claim that a strong labor market and strong growth will cause problems in inflation, this wasn’t seen last year (to be fair last year there were very high base effects, which are not present this year)
• He does not have great confidence in which path the economy is going to take for the rest of the year, coming data will be needed for this.
• Does not see where stagflation worries come from, still sees solid pace of growth, with inflation making progress in the last year, running under 3% currently.
• Wage pressures have eased, but still, a lot of progress is needed in this

[Aron]

I=6

• Powell said inflation has been falling more slowly than expected and that we will need to be patient as restrictive policy does its work.

  “We did not expect this to be a smooth road. But these [inflation readings] were higher than I think anybody expected,” Powell said at the annual general meeting of the Foreign Bankers’ Association in Amsterdam. “What that has told us is that we’ll need to be patient and let restrictive policy do its work.”

  “I do think it’s really a question of keeping policy at the current rate for longer than had been thought,” he said.

• He reiterated that he doesn’t expect a rate hike in the next meeting but more likely a hold.

  “I don’t think that it’s likely, based on the data that we have, that that the next move that we make would be a rate hike,” he said. “I think it’s more likely that we’ll be at a place where we hold the policy rate where it is.”

• Powell called today’s PPI report “mixed”.

Powell says inflation has been higher than thought and expects rates to hold...

[Aron]

I=5

• Federal Reserve Governor Christopher Waller wants to see several months of good inflation data before rate cuts.

  “The economy now seems to be evolving closer to what the Committee expected,” Waller said in prepared remarks for an appearance before the Peterson Institute for International Economics in Washington. “Nevertheless, in the absence of a significant weakening in the labor market, I need to see several more months of good inflation data before I would be comfortable supporting an easing in the stance of monetary policy.”

• However, he doesn’t think further interest rate increases are necessary.

  “Central bankers should never say never, but the data suggests that inflation isn’t accelerating, and I believe that further increases in the policy rate are probably unnecessary,” he said.

Fed Governor Waller wants 'several months' of good inflation data before...

[Aron]

I=6

• Fed minutes indicate that worries over lack of progress in the fight against inflation grew.

  “Participants observed that while inflation had eased over the past year, in recent months there had been a lack of further progress toward the Committee’s 2 percent objective,” the minutes reads. “The recent monthly data had showed significant increases in components of both goods and services price inflation.”

  “Participants noted that they continued to expect that inflation would return to 2 percent over the medium term. However, recent data had not increased their confidence in progress toward 2 percent and, accordingly, had suggested that the disinflation process would likely take longer than previously thought.”

• A number of officials questioned whether the policy is restrictive enough.

  “Although monetary policy was seen as restrictive, many participants commented on their uncertainty about the degree of restrictiveness. These participants saw this uncertainty as coming from the possibility that high interest rates may be having smaller effects than in the past, that longer-run equilibrium interest rates may be higher than previously thought, or that the level of potential output may be lower than estimated.”

• Some participants expressed willingness to tighten the policy further.

  “Various participants mentioned a willingness to tighten policy further should risks to inflation materialize in a way that such an action became appropriate,” the minutes note.

• The officials expressed worry that some consumers are resorting to riskier types of financing to make ends meet as inflation pressure persists.

  “Many participants noted signs that the finances of low- and moderate-income households were increasingly coming under pressure, which these participants saw as a downside risk to the outlook for consumption. They pointed to increased usage of credit cards and buy-now-pay-later services, as well as increased delinquency rates for some types of consumer loans.”

fomcminutes20240501.pdf

[moritz]

Hmm interesting.

It’s important to note that those meeting notes are from May 1, so before the latest CPI read from May 15.

@Magaly, did the latest CPI change anything regarding the prospect of further rate hikes from your assessment and observation of commentaries, or are rate hikes still something that could be on the table? (Regardless of what the markets are pricing in)

[Magaly]

It did not change anything for me in either direction. While it came in line with expectations mostly, there is still a lack of progress and short-term trends are still on the way up, especially for services.

But is not only about CPI data now, as they say, the risk between inflation and the labor market is in better balance now, and economic data since that meeting has come in slightly softer too.
Is a very tricky environment for the FED, in any other cycle they would probably ease soon or have already done so without the high inflation risks, but that is not the case in this one imo.

At this point, I think another hike is unlikely (no zero probability but low), but this could change at any moment with upcoming data, and I think that is what officials are referring too. If inflation continues to surprise to the upside, the risks of another hike will be increasing.
The minutes sounded more definitely more hawkish than what Powell tried to convey in the conference, and I do actually like that tone of sounding like they are taking inflation risks seriously.

That said I still struggle to see a catalyst for higher inflation (above 5% or something like that), since I don’t see a particularly strong economy either. Maybe the fiscal spending and deficit stimulus could be it, but I think I don’t understand that thesis or argument well enough to know or discard it for sure.

I am not sure if I agree with market pricing either yet, imo the probability of not seeing any rate cuts at all this year is not low since inflation could be more sticky than expected. Which in consequence will increase the risks for the labor market.
In the next FED projections, I think they will remove some of the cuts they have projected though, and I think what we will continue to see is the neutral or long-term rate increase in future forecasts.

[Aron]

I=8

• Fed left its benchmark funds rate unchanged at 5.25% to 5.50% as was largely expected while pointing out that there has been some progress in the fight against inflation in recent months, a statement that differed from the previous statement that said there was lack of further progress.

  “Inflation has eased over the past year but remains elevated. In recent months, there has been modest further progress toward the Committee’s 2 percent inflation objective,” the statement notes.

• In their “dot plot” projections, the committee now projects fed funds rate benchmark at 4.1% at the end of 2025, up 0.2% from the March outlook.

• The committee now see four cuts next year versus three projected in March.

• For 2024, the committee signaled just one rate cut instead of the three cuts projected in March.

[Magaly]

The dot plot moves up for most periods

• Seems there is no consensus on the number of cuts for 2024, very divided between 1 or 2 cuts in 2024
• The long-run rate continued to go up, and the bias seems to continue to be to the upside.
  
  
  
  
  

The FED is projecting unemployment to remain flat for the remainder of the year, I don’t see that being realistic to be honest due to the softening we have already seem this years, and their own projections of higher for longer rates.
THE FED is basically projecting the same economy we have currently for the end of the year, so I struggle to understand why they think they will need to cut then and not now.

Some notes I took:

• Very low PCE readings in the second half of 2023 will not allow for great numbers in the second half of 2024, not much improvement in Y/Y for the rest of the year.
• 1 or 2 is plausible, the committee sees it as multiple scenarios and is data dependent, and could change at any time.
• Today’s report adds to building confidence, but it is not definite. It comes after a few not-so-good reports.
• Gradually rebalancing strong labor market, still do not see anything more than that despite the softening
• No official has another hike into their base case
• Improvement in inflation has been a combination of supply distortions alleviating and demand until when this will continue is unclear
• Shelter rents will come down more slowly than originally though because of the internal dynamic of existing rents.
• Not waiting for anything to break to then react.

The market continues to expect 2 cuts in 2024 despite the FED median dot plot, and expects 1 cut every 2 meetings until July 2025

[Aron]

I=6
Powell reiterates that they want to see more disinflation before cutting interest rates

• Jerome Powell said they have seen progress in inflation over the past year but they want to see more before being confident enough to start cutting interest rates.

  “We’ve made quite a bit of progress and in bringing inflation back down to our target,” he said at a forum in Portugal.

  “The last [inflation] reading and the one before it to a lesser, lesser extent, suggest that we are getting back on the disinflationary path. We want to be more confident that inflation is moving sustainably down toward 2% before we start the process of reducing type or policies of loosening policy,” Powell added.

Powell says Fed has made 'quite a bit of progress' on inflation but needs...