FOMC meeting, January 30–31

Patience is a virtue: March rate cut is not the Fed’s ‘base case’

• The unanimous decision at the Federal Open Market Committee (FOMC or Committee) meeting to hold the federal funds rate at 5.25%–5.50% wasn’t surprising. As anticipated, the Fed dropped its tightening bias from the FOMC statement with the removal of the phrase “any additional policy firming.”
  
  
• Instead, the January statement favored a hawkish negative statement, saying the FOMC “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%.”
  
  
• During the press conference, Fed Chair Jerome Powell clarified what “greater confidence” entails. He noted that officials were encouraged by the strong disinflation progress over the past six months, especially as it has occurred without any notable economic pain. But, he stressed that the Committee needed more disinflation evidence over the coming months.
  
  
• This goes back to the fact that no official wants to be seen has having eased policy prematurely. With the burn of having tightened monetary policy too slowly still hurting, the majority of FOMC members, including Fed Chair Powell, want to be extra cautious in starting to ease monetary policy.
  
  
• That is likely why Powell did something very rare for a Fed Chair. His strong pushback against market pricing for a March rate cut could not have been clearer: “Based on the meeting today, I would tell you that I don't think it is likely that the Committee will reach a level of confidence by the time of the March meeting to identify March at as the time to cut.”
  
  
• Channeling the views of some of the more hawkish members of the FOMC, Powell added that the Committee looks “at more than the feds funds rate. We look at the financial conditions."
  
  
• These remarks reinforce our long-standing view that the Fed will start cutting rates in May with 100 basis points of rate cuts this year, coming at the May, June, September and December meetings.
  
  
• Fed Chair Powell signaled that the balance sheet runoff was going smoothly and that a decision to start tapering the quantitative process would likely be made in March. We believe the taper will either coincide with the first rate cut in May or start in June.
  
  
• In other news, it was refreshing to hear Powell confirm our view that the US economy is benefiting from the “holy grail” of noninflationary growth in saying, “I am not so worried about [strong growth]. We have had inflation come down without a slow economy and without important increases in unemployment.”
  
  
• Still, Powell appears more agnostic as to whether the rebound in productivity has legs — we believe it does: “My guess is that we may shake out and be back where we were.”

• He stressed another key topic that we have been highlighting over the last few months, saying that “cost fatigue” is likely a key driver of confidence: “It is fine the inflation is coming down, but the prices they are paying is [are] still high. So, that has to be a part of why people are unhappy.”
  
  
• One major question we have is whether Fed Chair Powell implicitly acknowledged a rate cut at every meeting once the easing cycle starts, by saying the first rate “is a highly consequential decision to start the process of dialing back on restrictions. We want to get that right.”