Rate Expectations

There was zero chance the Fed was going to cut rates today; instead it was all about what today’s meeting, the dot plot, and the press conference meant for the timing and pace of rate cuts in the months ahead.

Starting with today's statement, there was only one change from January, and it was a minor one. While prior language stated that job gains “have moderated since early last year but remain strong” today’s statement removed language concerning moderation and simply stated that “job gains have remained strong.” That – along with a slight adjustment lower to the unemployment rate forecast for 2024 –suggest that a stronger than anticipated job market has weakened Fed confidence that inflation will trend sustainably towards 2.0%.

The survey of economic projections provided more clarity. Forecasts for real (inflation-adjusted) GDP growth in 2024 rose to 2.1% from 1.4% in December. And with that outlook for stronger growth, their unemployment rate expectation shifted down to 4.0% from 4.1% while core inflation expectations rose to 2.6% from 2.4%. It's worth noting that with unemployment at 3.9% and core inflation at 2.8%, this suggests the FOMC members see very little movement in either category over the remaining nine months of the year.

While the combination of faster growth, higher inflation, and a stronger job market didn’t shift the Fed’s expectation for the equivalent of three 25 basis point cuts between now and year end, the distribution of forecasts shows that only one FOMC participant now expects more than three rate cuts will be appropriate this year, down from five members at the December meeting. And rate cut expectations for 2025 shifted to three cuts from four.

Beyond rate cuts, markets have been wondering when the Fed will start to taper back the pace of quantitative tightening (QT). During today’s press conference, Powell wouldn’t confirm or deny that the process could begin as soon as the next Fed statement on May 1st, but he did say that it would be appropriate to start “fairly soon” with plans to gradually cut the pace of roll-offs. In other words, May looks to be on the table.

We expect the Fed will start cutting rates in June. That said, the Fed should take a cautious approach once the process begins, with a primary focus on not cutting rates too aggressively or prematurely, which could re-ignite the inflation problem like the Fed did on multiple occasions under Chairman Arthur Burns in the 1970s. The economy is still growing, but we think it falls into recession before the year is out and that real GDP growth significantly lags the predictions of the FOMC members. This, in turn, heightens the risk that the Fed takes a more aggressive path on rate cuts in response to economic weakness, bringing the threat of re-accelerating inflation to the forefront in the years ahead.

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