The Federal Open Market Committee (FOMC) met this week for the third time this year. As widely expected, the FOMC left rates unchanged in the 5.25-5.5% range. However, following a streak of hotter-than-expected inflation data in recent months, investors’ main concern was that Chairman Powell would strike a more hawkish tone, potentially raising the possibility of further rate hikes in the future. Such concern turned out to be largely misplaced, and investors were able to breathe a sigh of relief. Here are the key takeaways from yesterday:
- The FOMC did acknowledge that “there has been a lack of further progress toward the committee’s 2% inflation objective” and Chairman Powell admitted that it will likely take longer for the Fed to gain enough confidence that inflation is headed in the right direction before it can begin cutting rates. However, he also clearly stated that the Fed still believes its current rate stance to be sufficiently restrictive, thereby effectively ruling out the need for further rate hikes.
- In a slight dovish surprise, the FOMC announced it will slow down the pace at which it is reducing the size of its balance sheet. Starting in June, the cap on runoff for Treasuries will be reduced from $60 billion to $25 billion per month, which is $5 billion lower than expected. The Fed clearly wants to prevent a repeat of the financial-market turbulence that struck during the previous round of balance-sheet trimming in 2019.
- The knee-jerk reaction from the market was positive for both stocks and bonds, with the S&P 500 rallying over 1% and the 10-year yield falling almost 10 bps. However, while the S&P 500 ended up surrendering all its gains before the market close, bonds managed to hold on to some of their gains. The amount of rate cuts priced in by the futures market by the end of this year, which has come all the way from 150 bps in January to 35 bps recently, was roughly unchanged. The Fed’s official projections, last updated in March and up for revision in June, still point to 75 bps worth of cuts. Most Fed watchers expect that to be revised down to either 25 or 50 bps next month, which would be more in line with current market pricing.
Bottom line: despite the inflation data surprising to the upside so far this year, the Fed retains its easing bias and signaled its willingness to be patient and not overreact to the recent data. This reduces the odds of a policy mistake, as we see signs that inflation is due to move lower as we progress through the year (see Carl’s recent note ECI is the Latest Sticking Point and our prior notes on rent inflation). As a base case, about 50bps of rate cuts by year-end seems like a reasonable scenario to us, with risks tilted to the upside (i.e. more cuts) if the economy slows down more than expected.
Source: Bloomberg, as of 5/1/2024
Sauro Locatelli CFA, FRM™, SCR™
Director of Quantitative Research
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