Fed Monitor: Fed to Hint at June Cut

Summary

• The Fed has already announced it would be on hold next week, and I expect it will keep three 2024 cuts in the SEP.
• The Fed will provide guidance on conditions for cuts, namely continued core PCE disinflation, faster services disinflation, and continued labour market rebalancing.
• Strong growth is unlikely to be a limiting factor for Fed cuts as long as disinflation and labour market rebalancing continue.
• The Fed is likely to list its principles for tapering QT.

Market Implications

• I expect the Fed to start cutting in June, in line with market expectations (Chart 1).

I expect the Fed to stick to its narrative of slower but continued 2024 disinflation, provide guidance on conditions required to start cutting, as well as on the broad contours of QT tapering.

Disinflation on Track

The Fed is likely to convey that disinflation is on track, including through only limited changes to the SEP. This is because data since the December SEP has been broadly consistent with the Fed forecast (Table 1).

The rise in unemployment is roughly consistent with the SEP and I therefore expect no change (Chart 11).

Growth has been persistently higher than the Fed expected: in Q4 it was 3.2% vs 2.6% in the SEP.  Since then, both the Atlanta and the NY Feds GDP nowcasts show slower growth, though still above trend (Chart 12). The Fed is therefore likely to raise its Q4/Q4 2024 growth forecast, possibly by about 20bp to about 1.6%.

MoM core PCE accelerated in January but a very low wage print in February NFP suggests no wage price spiral is underway (Charts 7 and 9). In addition, core MoM CPI slowed in February, especially OER and supercore services, which is likely to add to the Fed’s confidence that disinflation is continuing (Chart 8). I therefore expect the Fed to leave its Q4/Q4 2024 core PCE forecast unchanged for now.

Because the Fed sees the FFR as ‘well into restrictive territory’ it likely expects disinflation to continue and is therefore unlikely to change its FFR forecast.

What the Fed Requires to Start Cutting

Since the 30 January FOMC meeting, Powell has repeatedly stated that he needed more ‘good data’ rather than better data (Table 2). In addition, at the 8 March Senate hearings he stated that ‘we are not far from having enough confidence to cut rates’, which to me signals a June cut.  Other FOMC members have all stated that they were in no rush to start cutting.

In order to cut the Fed needs to see a continued sequential decline in YoY core PCE as well as:

• More progress in housing inflation (Chart 8).
• More disinflation in core services ex-housing and lower wage growth (Chart 9).
• These would offset risk that goods price deflation could end due to geopolitics and de-globalization (Chart 10).

If these conditions are met, the Fed could ignore above trend growth and assume that the current combination of disinflation with fast growth, which it believes reflects the recovery from the pandemic, is continuing.

I don’t expect Powell to discuss much financial conditions because of previous episodes of FOMC members discussion of financial conditions and ensuing reflexivity (Chart 2). In addition, consumer lending rates remain close to the cycle high (Chart 5).

Key risks that could bring rate cuts forward include economic weaknesses or banking distress, neither of which seem likely (Chart 6).

Key risks that could delay cuts include a marked increase in energy prices (Chart 14) or economic overheating (Chart 13).

Principles for QT Taper

In recent communications, the Fed has also indicated that QT would be discussed at the March meeting. Currently, the cap on reinvestments is $60bn/months for Treasuries and $35bn/month for MBS. Since the start of QT in June 2022, Treasury holdings have fallen by $1.1tn to $4.6tn and MBS holdings by $0.3tn to $2.4tn (Chart 3).

I don’t expect the Fed to provide a specific schedule yet but to discuss key principles including:

• Which indicators of reserves scarcity to rely on. So far, most of the portfolio runoff has translated into lower RRP. Reserves have increased by $0.3tn since the start of QT (Chart 4). Some FOMC members think the Fed can continue with QT at the current pace ‘for some time’, while others argue that the spread between private RRP and other money market rates signals reserves are too scarce.
• Composition of the balance sheet. Several FOMC members, including Powell, have expressed preference for the Fed not to hold any MBS on its balance sheet. In addition, FOMC members have also expressed a preference for holding shorter maturity Treasury paper, with Powell saying that he could see a case for shortening the maturity of Fed holdings.

Latest statement

Latest minutes

Current Fed Macroeconomic Forecast

Fed Unlikely to Cut in March

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Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)