U.S. PMI data shows continued economic expansion and the February leading indicators moved higher for the first time in 2 years. The most critical announcements were from the Federal Open Market Committee (FOMC) leaving the policy rate unchanged while still projecting -3/4 point in cuts by the end of the year.
The FOMC left the Fed Funds rate unchanged (March 20) with an upper bound of 5.5%. This was widely expected following recent increases in monthly consumer inflation readings which have the 6-month annualized core CPI almost double the 2% target rate. More closely watched were updated FOMC projections for Fed Funds for the full year. The updated Summary of Economic Projections (SEP) left the median Fed Funds projection unchanged from December implying -3/4 point in cuts through 2024.
The gist of the updated policy statement, in my opinion, is found in Chairman Jay Powell’s statement, “We’ve got nine months of 2-1/2 percent inflation now and we’ve had two months of kind of bumpy inflation. We were saying that we’ll, it’s going to be a bumpy ride. We consistently said that. Now here are some bumps and the question is, are they more than bumps? And we just don’t, we can’t know that.”
In addition to the FOMC forecasting a lower target rate over the coming months, the committee announced the pace of Quantitative Tightening (QT) will be slowed “fairly soon.” Initial balance sheet runoff will likely focus on Treasuries as “there isn’t much runoff among MBS.” Powell elaborated his thoughts on slowing QT stating, “The idea is, and this is in our longer run plans, that we may actually be able to get to a lower level, because we would avoid the kind of frictions that can happen. Liquidity is not evenly distributed in a system and there can be times when in the aggregate, reserves are ample or even abundant. But not in every part, and those parts where they’re not ample, there can be stress and that can cause you to prematurely stop the process to avoid the stress and then it would be very hard to restart we think, so something like that happened in ’19 perhaps, so that’s what we’re doing, we’re looking at what would be a good time and what would be a good structure and fairly soon is words that we use to mean, fairly soon.”
Various other press conference statements of note included Powell stating, “I mean my instinct would be that rates will not go back down to the very low levels that we saw where all around the world there were long run rates that were at or below zero in some cases.” I think this is important in thinking about yield curve shape and eventual return to positive slope. I think too much consensus opinion centers around a return to ultra-low short-end rates when adjustments that more closely follow mean reversion are probably more likely. You can see the market beginning to reflect this base case as Fed Futures more closely align with the SEP projections.
Powell also recognized the upcoming challenge from monthly roll rates when thinking about back half 2024 changes in last twelve month inflation readings noting, “in the second half of the year you have some pretty low readings so it might be harder to make progress as you move that 12-month window forward.” While the Fed prepares to ease monetary policy from its current restrictive level, the S&P Global March Flash PMI (March 21) coincided with continued economic expansion in 1Q24. Congress has also moved forward its bipartisan minibus bill that continues high levels of deficit spending fiscal stimulus.