Monetary Policy & Inflation | US
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Summary
- In January, the FOMC announced moving to an easing bias and that it will not cut until it sees more ‘good’ disinflation data.
- Higher-than-expected January inflation has turned the FOMC more hawkish.
- The Federal Reserve (Fed) is likely to start communicating its plans for quantitative tightening (QT) at the March meeting.
Market Implications
- I expect the Fed to start cutting in June, in line with market expectations (Chart 1).
At the 30 January FOMC meeting, the Fed signalled moving to an easing bias but without a cut in March. All FOMC members have since stressed that the Fed is in no rush to cut.
Fed Chair Jerome Powell said he needed ‘more good inflation data’ rather than ‘better data’ before cutting. Good rather than better data aligns with the slower disinflation shown in the December 2023 SEP, with core PCE falling 80bp in 2024, against 1.3ppt/year in 2022-23. The Fed expects US disinflation to enter its slower last mile.
Also, a slower disinflation trend makes interpreting inflation prints harder.
Higher-than-expected January CPI and PPI prints have turned FOMC members more hawkish (Chart 7).
To cut, the Fed needs a continued sequential decline in core PCE as well as:
- More progress in housing inflation (Chart 8).
- More disinflation in core services ex-housing, driven by lower wage growth (Chart 9).
- The above would offset risk of goods price deflation ending due to geopolitics and deglobalization (Chart 10).
- Growth closer to trend than currently indicated by the Atlanta Fed nowcast, which at 2.9% runs far above the FOMC’s long-term 1.8% growth estimate (Chart 12).
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 markedly increased energy prices (Chart 14) or economic overheating (Chart 13).
The Fed has also recently indicated that QT will be discussed at the March meeting, that it was likely to slow when the Fed’s RRP balance lowers, and that returning to the pre-pandemic Fed balance sheet is unlikely (Charts 3 and 4).
Current Fed Macroeconomic Forecast
Recent FOMC Comments
March Cut Unlikely
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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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