Fed Watch: Preparing for rate cuts

Once again, the Fed kept key rates unchanged. Still, the first steps were taken to start a rate cutting cycle at one of the upcoming meetings. The Fed has gained confidence in the disinflation trend, yet the central bankers still want to see more confirming data. Chair Powell sees a rate cut at the next meeting in March as unlikely. So, the second quarter it is!

Market expects a faster cutting cycle than the Fed - momentum is on its side
* based on short-term forwards of the EFFR OIS curve; FOMC projections as of December 2023.
Source: LSEG, RBI/Raiffeisen Research

The Federal Open Market Committee (FOMC) decided to keep the federal funds rate unchanged at a target range of 5.25 - 5.50%. Interest rates have been kept at this level since July 2023. For the first time, however, the Fed has abandoned its hawkish bias. So far, the monetary policy statement read "in determining the extent of any additional policy firming". Now the Fed states "in considering any adjustment to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook and the balance of risk". Thus, the wording changed from "additional firming" to "adjustment", which is more symmetric. In order not to be seen as a confirmation of an imminent rate cut, the statement further reads "the Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%". Besides these major changes to the monetary policy statement, the FOMC also stated that the risks to achieving its dual mandate (full employment and price stability) are moving into better balance. Yet, the economic outlook is uncertain and "the Committee remains highly attentive to inflation risks".

During the press conference, Chair Powell was surprisingly outspoken about the key rate path ahead. Besides the usual suspects of emphasizing data-dependency and the Fed's meeting-by-meeting approach, he stated that a March rate cut is not likely. The Fed is looking back at six months of good inflation data and the FOMC's confidence that price stability will be regained has grown, but the Committee wants to see a continuation of the current inflation trend. How many more months of good inflation data are necessary for the Fed to embark on a cutting cycle has not been shared though. Putting things together, it seems likely that a first rate cut will occur in the second quarter (in line with our forecast).

At the end of the press conference, Chair Powell shared that discussions about a potential phasing out of quantitative tightening have started at this meeting. In-depth discussions will be held at the March meeting. While QT does not necessarily need to be stopped at the same time as the rate is decreased, Chair Powell hinted to the fact that it cannot be ruled out.

On markets, the FOMC meeting came with volatility. The release of the monetary policy statement was accompanied by falling US Treasury yields. During the press conference, Powells reference that a March rate cut is not the baseline triggered a repricing to the upside. On the day, Treasury yields, however, are closing at lower levels. EUR/USD has seen a shift to the downside, thus, the Fed meeting was rather US dollar supportive.

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Franz ZOBL

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Franz joined Raiffeisen Research's Economics, Rates, FX team in 2020 primarily focusing on US monetary policy, benchmark yields and EUR/USD. Prior to joining RBI, he worked as a research economist in the financial sector. He holds a PhD from the London School of Economics and studied at the Vienna University of Economics, the University of Vienna as well as Tilburg University. He is a published author within the field of macroeconomics and has a passion for economic history.