By Andrew Moran
The Federal Reserve left interest rates unchanged at their highest levels in 23 years as monetary policymakers have observed “a lack of further progress” toward the central bank’s 2 percent inflation target.
Fed officials noted that the risks to accomplishing its dual mandate of maximum employment and price stability have shifted to a better balance over the past year. Still, the “economic outlook is uncertain,” and the policymaking Federal Open Market Committee (FOMC) is “highly attentive to inflation risks.”
For now, rate-setting committee members do not believe that “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 will continue to monitor the implications of incoming information for the economic outlook,” the FOMC statement reads. “The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals.”
The Fed also announced that it would start slowing the pace of reducing its securities holdings by decreasing the monthly reduction cap on Treasurys to $25 billion from $60 billion. As for agency debt and agency mortgage-backed securities, the central bank will keep the tapering at $35 billion per month.
It will start in June.
‘Policy Is Still Restrictive’
The result was not surprising for market watchers. Investors have been primarily focused on the future and whether the Federal Reserve will turn hawkish or dovish in the coming months.
The timing of when the Fed might cut interest rates is “in an indefinite holding pattern,” according to Greg McBride, chief financial analyst at Bankrate.
“The Fed statement made special mention of the fact that there has been a noticeable lack of progress in the past few months toward the goal of 2 percent inflation,“ he said. ”Calling that out in the first paragraph is tantamount to saying that interest rate hikes are not coming soon.”
Fed Chair Jerome Powell told reporters that the current policy rate “is still restrictive” and weighing on demand, including in the labor market.
“We don’t like to react to one or two months data, but this is a full quarter, and I think it’s appropriate to take signal,” he said.
While he does not believe that the next policy move will be a hike, Mr. Powell assessed various economic outlooks that would suggest interest rates might need to stay higher for longer.
“I think it’s unlikely that the next policy rate move will be a hike. I’d say it’s unlikely,” he said.
This comment ignited a sharp rally in U.S. stocks.
The leading stock market benchmark indexes popped by as much as 1.1 percent during the Fed chief’s remarks.
U.S. Treasury yields were mostly red across the board, with the benchmark 10-year yield sliding below 4.64 percent. The two-year yield slumped below 5 percent, while the 30-year bond dropped below 4.74 percent.
The U.S. Dollar Index, a gauge of the buck against a basket of currencies, sank on the news below the 106.00 mark.
Mr. Powell anticipates a continued decline in inflation, although his confidence is not as strong as before.
“My expectation is that we will, over the course of this year, see inflation move back down but my confidence in that is lower than it was because of the data that we’ve seen,” he said.
As for the broader economy, Mr. Powell rejected stagflation fears as growth is solid, inflation is slowing, and unemployment is low.
“I don’t know where that’s coming from,” he said. “I don’t see the ’stag‘ or the ’flation.’”
Stagflation is a combination of stagnating growth, higher inflation, and rising joblessness.
Bryce Doty, senior portfolio manager and senior vice president at Sit Investment Associates, said the more notable news from the two-day meeting was the decision to ease the balance sheet runoff campaign.
“Bigger news might be the slowing of balance sheet reduction of treasuries cutting the pace from $60 billion to $25 billion a month,” he said in a note. “The question is if that change is due to some liquidity stress that the Fed is worried about.”
The Fed’s tapering of its balance sheet reduction was about $5 billion larger than market forecasts.
Watching Inflation Like a Hawk
Over the past month, monetary policymakers have been reading from the same script, conveying to the public that there is little urgency to cut interest rates. Because the U.S. economy is still growing and creating jobs, the central bank can afford to wait until members of the rate-setting FOMC have achieved enough confidence to pivot.
“We’ve said at the FOMC that we’ll need greater confidence that inflation is moving sustainably towards 2 percent before [it will be] appropriate to ease policy,” Mr. Powell said last month. “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.”
The shift in policy stance has done a complete reversal.
In December 2023, the Fed chief surprised observers by signaling that rate cuts were coming, just days after telling a college campus that it would be premature to entertain the idea of easing policy.
The Summary of Economic Projections in December 2023 and March suggested that the institution would be slashing interest rates three times.
However, according to the CME Fed Watch Tool, the futures market is penciling in just one or two quarter-point reductions later this year as the primary inflation metrics have reaccelerated.
Jeff Klingelhofer, co-head of investments and portfolio manager at Thornburg Investment Management, contended that it was a mistake to tout rate cuts. He thinks the Fed will only cut once this year.
“It has been my belief for years that the Fed would not proactively cut rates,” Mr. Klingelhofer said in a note. “I had to adapt when the Fed told us they would move ahead of inflation breaching 2 percent to the downside. The challenge today is that inflation is sustainably high, and it is accelerating.”
According to the Federal Reserve Bank of Cleveland’s Inflation Nowcasting model, the next Consumer Price Index report will show the annual inflation rate unchanged at 3.5 percent. This is well above the Fed’s 2 percent target rate.
The regional central bank forecasts that the Fed’s preferred inflation gauge—the Personal Consumption Expenditures price index—will also be flat at 2.7 percent.
While investors have not given significant weight to a rate hike, the expectation is that rates will be higher for longer and monetary policymakers will wait for tighter policy to work.
