The Federal Reserve left interest rates unchanged after its two-day policy meeting that concluded Wednesday, dashing hopes for an immediate cut to borrowing costs. However, Fed Chairman Jerome Powell signaled rate cuts could come later this year if inflation continues to ease.
Key Takeaways
- The Fed left its benchmark federal funds rate unchanged in a target range of 4.5% to 4.75%, as widely expected
- Policymakers predict leaving rates at current levels for “some time” until more evidence of cooling inflation
- Markets anticipate rate cuts starting in the second half of 2024 if price pressures continue slowing
- The Fed also laid groundwork to begin slimming down its nearly $9 trillion asset portfolio
Rates on Hold, But Cuts Could Come in H2 2024
Financial markets had largely priced out the chances of a rate cut at this week’s Federal Open Market Committee (FOMC) meeting after recent economic data showed inflation, while slowing, remains well above the Fed’s 2% target.
“We can now say I think for the first time that the disinflationary process has started,” Powell said at a news conference following the Fed’s statement. However, “it has a long way to go.”
The Fed chief stressed policymakers need to see “substantially more evidence” to be confident that inflation is on a sustained downward path, particularly on the wage growth front. Most officials predict leaving rates unchanged at current levels for “some time” until clear signs emerge that price pressures are abating.
Fed Policy Path Implied by Market Pricing
| Date | Implied Fed Funds Rate | Chance of 0.25% Rate Cut |
|---|---|---|
| March 2024 | 4.6% | 8% |
| June 2024 | 4.4% | 31% |
| September 2024 | 3.9% | 63% |
| December 2024 | 3.4% | 76% |
Source: CME FedWatch Tool
Futures markets show investors anticipate rate cuts commencing in the back half of 2024 if monthly inflation figures continue trending down. The timing hinges on the trajectory of consumer prices and whether the Fed believes it has tamed inflation without triggering a recession.
“The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time,” the Fed said.
Watching the Balance Sheet Reduction Path
The FOMC statement also opened the door to finally beginning the reversal of pandemic-era asset purchases known as quantitative tightening (QT) – an incremental move toward policy normalization.
Officials said they agreed the time had come to consider slimming down the Fed’s near $9 trillion balance sheet bloated with bonds and mortgage-backed securities. Powell noted policymakers will likely announce a detailed QT plan at the next meeting in March.
“What we need is a plan for reducing the size of the balance sheet…over a period of time in a predictable manner,” Powell remarked. “The time for that is now upon us and we’ll be laying that out.”
Experts warn the effects from a contracting Fed balance sheet could have a tightening impact on financial conditions similar to additional rate hikes.
Inflation Still Elevated Despite Progress
The Fed’s latest policy update came just hours before a report Thursday morning showing personal consumption expenditures (PCE) – the central bank’s preferred inflation gauge – rose 5.4% in December from a year earlier.
While down from a recent peak of 7% last summer, the inflation metric remains well above policymakers’ 2% comfort zone. Stubbornly high prices for essentials like food, energy and shelter continue squeezing American budgets.
A separate Labor Department report also out Thursday showed weekly jobless claims rising more than anticipated last week, sparking fresh questions about the health of the jobs market after blockbuster gains in 2022.
“There are some signs that the labor market is cooling…but it remains tight overall,” noted Sarah House, Senior Economist at Wells Fargo.
Powell Pushes Back on Recession Fears
Despite fears of an impending downturn, Powell maintains the disinflationary process can stick without triggering mass layoffs or a severe recession.
“My base case is that the economy can return to 2% inflation without a really significant downturn or really big increase in unemployment,” he stated Wednesday. “There’s nothing in the economy right now that suggests it’s close to or vulnerable to a recession.”
However, the Fed chair cautions there remains an arduous road ahead with interest rates poised to linger at restrictive levels for some time until convincing evidence shows pricing power is subsiding.
“Restoring price stability when inflation is high can require measures that are not popular in the short term as we raise interest rates to slow the economy,” Powell conceded. “The job is not yet done.”
So while an immediate rate cut is off the table, Fed messaging indicates easing could come later this year if actual inflation keeps trending down toward their goal. But policymakers are determined to keep rates high in the meantime, risking economic pain in order to decisively crush the inflation outbreak.
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