The Fed isn’t ready to cut rates, as inflation risks remain

The takeaways from this Fed meeting are that the Fed is not ready to cut interest rates right now, however, they are happy with the disinflation trend, and the Fed chair sees rates coming down at some point this year. Jerome Powell was not as specific as Christine Lagarde when it comes to the timing of rate cuts, and the market does not see a March rate cut as likely, with the CME Fedwatch tool now predicting a 36% chance of a rate cut at the next meeting.

Ahead of this meeting we said that the Fed may push back on their prior dovish rhetoric, because of the strength of economic growth and the stock market rally. They did push back on this, and the market has listened. Stock markets have been addicted to the prospect of rate cuts, and this has driven stock markets higher so far this year. But the reality is that the Fed is not yet ready to cut rates, and this could tone down the bullish sentiment in the market as we move into February.

No pre-commitment to rate cuts

Powell was not explicitly dovish at this meeting, and he was not willing to pre-commit to rate cuts. This has reduced expectations of a rate cut in March, however, there are still more than 5.5 rate cuts priced in for 2024, even though the Fed is not yet willing to commit to the first cut. Thus, there may need to be more adjustment on rate cut expectations, which could make it harder for stocks to broadly rally from here.

Changes in the Fed statement

Overall, the tone of the accompanying statement was more upbeat on economic growth and also more balanced about the prospect of inflation returning to target. The economic outlook was upgraded, saying that economic activity had been ‘expanding at a solid pace’ and it maintained the view that job growth remained strong, and the unemployment rate remained low. The Fed cut out its prior comment about tight financial conditions weighing on economic growth, and instead said that the Committee ‘judges that the risks to achieving its unemployment and inflation goals are moving into better balance’. This could be considered less hawkish than before, when they asserted that a rate hike was possible, but it certainly was not dovish.

3 key takeaways from the Fed statement

The new statement suggests 1, that the Fed is high fiving itself at being able to bring inflation into better balance at the same time as economic growth continues to expand at a solid pace. 2, the Fed is clearly maintaining its bias to cut rates and 3, the Fed has acknowledged the disinflation trend, but they still need to be convinced that this trend is sustainable.

March rate cut unlikely

The penultimate paragraph in the statement dealt those expecting a March rate cut a fatal blow. The Fed is not yet ready to cut interest rates and said, ‘The Committee does not expect that it will be appropriate to reduce (interest rates) until it has greater confidence that inflation is moving sustainably towards 2%’. This is essentially the Fed saying that they can’t possibly cut rates with growth rates this high and rising real wage growth, at the same time as headline inflation has been ticking higher.

Inflation is key  

Powell’s press conference is clarifying the message from the statement. Powell said that the Fed needs more time for price gains to continue to follow the disinflation trend of the last 6 months, and the Fed is looking for a continuation of the ‘good data’ they have been seeing. Thus, in the absence of an inflationary shock then rate cuts are coming.

Powell also said the FOMC has been pleased by how well the labour market has held up. Since the Fed has a dual mandate, this suggests that the Fed is less concerned about the unemployment rate right now and is instead fully focused on inflation. He also confirmed that rates are at the peak for this tightening cycle, although the Fed is unwilling to pre-commit to rate cuts and will only make decisions on a meeting-by -meeting basis. From a financial market perspective, this is likely to increase volatility in stocks, bonds and the dollar in the lead up to major economic data releases like NFPs, PCE and CPI data.

Powell doesn’t follow Christine Lagarde’s summer talk

Unlike Christine Lagarde, who pointed to the summer as the likely time that the ECB will cut interest rates, Powell won’t commit to a particular season to cut rates, instead he says that it will be appropriate ‘to dial back at some point this year’. Unlike Lagarde, he also caveated in his comments by saying that the Fed has been wrong before, and they are prepared to hold rates for longer, if appropriate, and this has triggered a reduction in expectations of a March rate cut. Ultimately, Powell didn’t give anything away, which is infuriating for traders, however, is clever from a policy standpoint, when the global economic outlook is unclear.

Rate cuts could be some months’ away

The key word in the statement and the press conference was ‘confidence’, The Fed doesn’t yet have confidence that inflation is on a sustainable path lower, and Powell also said that inflation remains elevated, which suggests that the Fed will need to see a notable shift lower in the price data before they get the confidence to cut rates. From an outsider’s perspective, this could take time, so the market should not hold its breath waiting for rate cuts. While Powell won’t commit to the timing of rate cuts, it feels like they could be several months away.  

Doves not in control at the Fed

This is why Powell confirmed that there was no proposal to cut rates at this meeting, and he said there is a ‘healthy disparity of views’ at the FOMC for when rates should be cut. Powell also added that the Committee remains some way off a consensus. Thus, the doves do not have control at the Fed, and this could further erode the prospect of near-term rate cuts, which may weigh on market sentiment in the medium term.