Fed officials are facing a number of questions ahead of this week's two-day policy meeting, and investors are hoping that Chairman Jerome Powell will provide some answers.
Has inflation really stopped cooling? Has the Fed's outlook on that cooling changed? If so, what does it mean that we can expect a rate cut in 2024?
Investors are confused and have a cacophony of views ahead of the Fed's deliberations in Washington. Some say nothing has changed, while others say everything has changed. There are many voices in between.
“Inflation is somewhat stagnant,” said Wilmer Stith, fixed income portfolio manager at Wilmington Trust. “The question is whether it will remain stagnant until 2024.”
Traders are backtracking on their expectations for when the Fed will cut rates, as the conversation shifts from when the Fed will start cutting rates to whether it will do so before the end of the year.
There was a time this year when the market was betting on six interest rate cuts starting in March. That slipped into June and then into July. They are currently pricing in just a 45% chance of a first rate cut in September.
Virtually no one expects any action to be taken at this week's meeting, which ends Wednesday afternoon. The Fed is widely expected to keep interest rates on hold, at a 23-year high.
“There's still a lot of time in 2024,” Stith said. “It's not going to be six rate cuts, but it's clear that they're going to take some action to lower rates this year.”
Not all Fed watchers are worried about overheating inflation. Luke Tilley, chief economist at Wilmington Trust, said his outlook hasn't changed much.
He said the housing component of inflation is actually driving inflation to remain high, but it is still slowing year-on-year.
“I don't think the evolution of inflation is stagnant. That's what bothered me,” Tilley said.
He still believes the Fed's preferred measure of inflation, the personal consumption expenditure (PCE) index, will continue to fall enough for the Fed to start cutting rates by mid-year.
The last reading in March was 2.8%, and Tilley noted this was still within the central bank's year-end forecast of 2.6%.
“Mr. Powell has said many times over the last year that we need to start cutting before we get to 2%,” Tilley said.
Tilley expects the first rate cut to be delayed to July rather than September. In Tilley's view, there are still three cuts left.
However, if the Fed does not cut rates in July, he said he would wait until December to do so to avoid getting too close to the November presidential election.
Former Kansas City Fed President Esther George said she believes the Fed still has a chance of cutting rates in the second half of the year, and that two rate cuts this year are reasonable. But starting cuts in July would require a “quite dramatic affirmation” of the economic slowdown.
Mr George also acknowledged that the cuts could be delayed into December and that meaningful cuts could not occur until 2025.
He said the Fed could wait because inflation expectations appear to be hovering around target and wages are moderating.
But there are risks to waiting, she added. The longer the Fed holds interest rates at current levels to curb inflation, the greater the risk of a recession.
”[The Fed] “We want to avoid hurting the economy with these interest rates, but we don't know if that's possible,” George said.
Mr. Powell himself reversed course in the weeks leading up to this week's meeting, commenting on April 16 that it would “take longer than expected” to gain the confidence needed to bring inflation down to levels. He suggested that interest rates are likely to remain high for a long time. The central bank's target is 2%.
“Given the strength of the labor market and the historical development of inflation, it is appropriate to allow more time for restrictive policies to take effect and to let data and the evolving outlook guide our guidance,” Powell said. Stated.
His comments marked a departure from previous assurances that the overall outlook had not changed much despite tougher-than-expected numbers in the first two months of the year.
Chairman Powell warned on April 16 that he did not expect to see any progress in the PCE inflation numbers, and he was right.
PCE rose 2.8% year-on-year in March, the same level as February and a tenth of a percentage point higher than expected.
He also said that three- and six-month inflation rates based on PCE would be higher.
Tilley said an increase in the three-month annualized rate of core PCE to 4.4% would be enough for the Fed to have some concerns that inflation is accelerating. Still, he added, the number is increasing significantly due to seasonality.
Year-on-year comparisons from June onwards may be even more difficult as inflation began to decline rapidly in the second half of last year. This could make it difficult for the Fed to be confident that inflation is low enough to start cutting rates.
George expects the central bank this week to reinforce Powell's view that first-quarter inflation data do not increase the Fed's confidence that inflation will return to 2%.
“They're going to have to continue to send the message that inflation has been stagnant for the first three months of this year and they don't want to see it accelerate,” George said.
One Fed watcher expecting hawkish comments this week is Matt Ruzzetti, chief U.S. economist at Deutsche Bank Securities.
He currently expects only one rate cut this year, in December, followed by a smaller rate cut in 2025. Starting next year, the Fed expects to cut interest rates by just under 4% by the end of 2026.
“If inflation data picks up again, we will likely see a more hawkish message at the FOMC meeting in May,” Ruzzetti said in a research note.
“Signals from the meeting should indicate that the likelihood of rate cuts at future meetings has decreased.”
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