MNI FED WATCH: On Hold But Shifting To Neutral Guidance
Many not convinced the easing cycle will begin in March but the FOMC will create the option of doing so.
The Federal Reserve is expected to hold rates at a 23-year high rate of 5.25%-5.5% range for a fourth straight meeting Wednesday and shift its forward guidance to more neutral language in anticipation of lowering rates later this year.
Several former senior Fed officials told MNI the central bank will likely wait until summer to start an easing cycle, in light of robust growth and solid employment data. However, with inflation fast declining, more dovish officials are sure to argue March would be a live debate on a first quarter-point cut.
The FOMC "could soften its language on inflation a little bit and they could make the discussion of the future path of policy essentially neutral, not still point toward policy firming," William English, former director of the Fed's division of monetary affairs, told MNI. (See: MNI INTERVIEW: Fed Can Wait Until Summer To Cut Rates-English) The policy statement currently states the FOMC is "determining the extent of any additional policy firming that may be appropriate."
He and Dennis Lockhart, former Atlanta Fed president, both expect three rate cuts this year, to match the FOMC's median projection in December and two fewer than markets are currently pricing. Lockhart told MNI barring severely worrisome data, policymakers "will tend to delay as long as they can a major change in policy direction so as to have the most convincing evidence" on inflation. (See: MNI INTERVIEW: Ex-Fed's Lockhart Sees No Rush To Cut In 1H)
SUPERB DATA
A major reason to wait is officials are not yet ready to declare victory in containing prices, the ex-officials said.
Core PCE inflation rose just 0.172% in December and 2.9% over the year, the first time since March 2021 that it's been below 3%. The six-month annualized Dallas Fed trimmed mean inflation rate has fallen to 2.6% from 3.4% in July. Over the year, it's fallen by almost 1 pp to 3.3%.
Yet some still fear new supply chain snarls could boost goods prices, and services inflation could be stickier for longer than expected. Supercore prices in the service sector and rental rates in the housing market are "leveling off at levels that not not consistent with the Fed's inflation target," Andrew Levin, who was special advisor to the Fed Board, told MNI. (See: MNI INTERVIEW: Fed Could Hold Longer On 'Entrenched' Inflation)
Wage growth is also still running above levels consistent with 2% inflation, with employers adding a stronger-than-expected 216,000 jobs in December and the unemployment rate little changed at 3.7% to end the year. More good news on inflation is needed to put those concerns to rest.
QT
The FOMC is expected to begin discussing its plan to slow the pace of quantitative tightening without making a final decision. A tapering plan could be announced in the first half, but officials will aim to press on with some form of balance sheet reduction for as long as bank reserves are ample and there are no signs of a hard landing, former New York Fed staffers told MNI. (See: MNI: Fed Could Soon Taper QT But Halt Further Off - Ex-Staffers)
Dallas Fed President Lorie Logan, who previously headed the markets desk at the New York Fed, said slowing QT would reduce the likelihood that the Fed will have to stop the process prematurely due to funding market disruptions. However, since mid-2022, Fed assets have shrunk by USD1.3 trillion while bank reserves have actually risen by USD350 billion, she noted.