The American Federal Reserve is inching closer to cutting interest rates but first wants greater certainty that inflation has truly been conquered. The first move at the June meeting is still likely if the next inflation data show progress. The Fed still expects three interest rate cuts this year, as suggested by the latest “dot plot” chart. The dollar weakened, and Wall Street hit new historical records.
As expected, the Fed did not change key interest rates. The target range therefore remains at 5.25-5.50 percent. The statement after the meeting largely resembled that of January. Forward guidance was not changed. The Fed again stated that it does not expect a cut to the target range until greater certainty is gained that inflation will be persistently heading towards 2 percent. The US central bank also continues to reduce its securities portfolio (QT) at an as yet steady pace. Yesterday’s decisions were unanimous.
Besides the decision on rates, the market also received other data that could be interpreted. The Federal Reserve presented new quarterly projections. Economic growth expectations for this year have been significantly raised. GDP in 2024 is expected to be 2.1 percent, up from 1.4 percent previously, and in 2025, growth momentum should level at 2.0 percent (up from 1.8 percent in December). The long-term (2026) expected economic growth is also 2 percent, up from 1.9 percent. The Fed expects PCE deflator-measured inflation to slow to 2.4 percent and to slightly deviate from the 2-percent target by the end of 2025, at 2.2 percent (previously 2.1 percent).
Given the improved growth prospects, the assessment of the likely appropriate path of interest rates (“dot plot”) has been modestly raised for some periods. The median of Fed officials still expects three 25-basis-point interest rate cuts this year. However, only 10 out of 19 Fed members advocate for three or more rate cuts, while 9 see only two or fewer. This means that only one person would have to change camps, and the median would shift to two moves. For the years 2025-2026, the interest rate path was raised by 25 basis points compared to December estimates.
Powell was quite balanced at the conference, so nothing changed there. He reiterated the market-known statement that the cost of money is currently probably at its peak and that it should be lowered “at some point this year.” No specific date for June was given, but the market began to price in a greater chance of a start in this month. The Chairman referred to recent inflation data, which were quite high but did not influence the Fed’s assessment of the disinflation process.
The topic of the Fed’s balance sheet reduction was widely discussed, but no decision was made. Here, change is likely in May and will involve slowing the pace of quantitative tightening.
The Fed still doesn’t have 100-percent clarity on when to start cutting rates. It needs more data, which will serve as evidence that inflation will fall to the target in the longer term. Given the recent surprisingly high figures, it is unlikely that the Fed will gain such certainty at the next meeting on May 1. Therefore, the earliest date for the first interest rate cut is June, and the market has interpreted it this way. The tone of yesterday’s conference and the presented data is dovish, investors were somewhat afraid that the Fed could become more restrictive after the recent CPI and PPI publications, and that the three cuts this year may not materialize.
The market reaction is quite pronounced and clear. The economy is in good shape, and forecasts are better than before. Monetary easing will begin this year and will proceed at a similar scale as assumed in December. Inflation, despite its current spike, is heading towards the target in the long term, and unless there are extraordinary events, the target will be reached. The dollar weakened (EURUSD indicates 1.0935), Wall Street again filled with optimism and the main indices set a new ATH (all-time high) level. Yields on US bonds fell, gold gained and for the first time in history crossed the $ 2200 cap.
Lukasz Zembik Oanda TMS Brokers
