MNI FED WATCH: Interest Rate Cuts Begin To Come Into View

The Federal Reserve's pandemic era interest-rate hiking cycle has likely crested without tipping the U.S. economy into recession and policymakers are prepared to debate when to start cutting, Chair Jerome Powell said Wednesday.

The Federal Open Market Committee acknowledged after a two-day meeting that no more hikes are likely needed to keep inflation moving toward their 2% goal next year, and all but two out of 19 officials saw the Fed's benchmark overnight rates falling next year.

"No one is declaring victory. That would be premature. And we can't be guaranteed of this progress. So, we're moving carefully in making that assessment of whether we need to do more or not," Powell said. "The other question of when will it become appropriate to begin dialing back the amount of policy restraint in place -- that begins to come into view and is clearly a topic of discussion out in the world and also a discussion for us at our meeting today."

Investors moved to price in an 80% chance of a first quarter-point rate cut in March and more than five reductions over the course of 2024. The U.S. dollar sold off aggressively, with the USD index down roughly 0.85% since the Fed decision.

SO FAR, SO GOOD

Inflation has already fallen faster than the FOMC expected this year with progress across goods, housing and other services but more is required to make the FOMC confident about easing, Powell said.

Headline PCE inflation is estimated to have been 2.6% in November, with core PCE inflation at 3.1% he said, but getting it all the way to 2% will take some time. The median FOMC projection is for inflation to end next year at 2.4%.

"The lower inflation readings over the past several months are welcome, but we will need to see further evidence to build confidence that inflation is moving down sustainably toward our goal," Powell said.

Supply chains and an expansion of the labor supply still has "some ways to run" in helping ease price rises, while optimism grows that even dampening demand -- normally a tall task -- may play out differently this time, he said.

"Inflation keeps coming down. The labor market keeps getting back into balance. It's so far, so good, although we kind of assume that it will get harder from here. But so far, it hasn't," Powell said. "Famously, the service sector is thought to be stickier, but we've actually seen reasonable progress in non-housing services, which was the area where you would expect to see less progress."

HANGING ON TOO LONG

The labor market has similarly exhibited signs of a soft landing, Powell said. The unemployment rate remains low at 3.7%, and officials expect the "rebalancing" of supply and demand to continue, easing upward pressures on inflation, he said. The median unemployment rate projection rises to just 4.1% at the end of next year as growth dips to 1.4% from 2.6% this quarter.

"I have always felt since the beginning that there was a possibility, because of the unusual situation, that the economy could cool off in a way that enabled inflation to come down without the kind of large job losses that have often been associated with high inflation in tightening cycles. So far, that's what we're seeing," Powell said.

The Fed is "aware of the risk that we would hang on too long" to high rates, he said. "We know that that's a risk, and we're very focused on not making that mistake."

Still, victory isn't yet assured. Above-potential growth could mean it takes longer to get to 2% inflation, Powell said.

"It could even mean, ultimately, that we would need to hike again," he said. "Participants didn't write down additional hikes" at this meeting, he said. "But participants also didn't want to take the possibility of further hikes off the table."