Monetary Policy & Inflation | US
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Summary
- The FOMC has moved to an easing bias but wants more ‘good’ disinflation data before cutting.
- The Federal Reserve (Fed) is likely to start communicating its QT tapering plans at the March meeting.
Market Implications
- I expect the Fed to start cutting in May or June, in line with market expectations (Chart 1).
At the 30 January FOMC meeting, the Fed signalled moving to an easing bias but without cuts in March. All FOMC members have since stressed the Fed is in no rush to cut.
Fed Chair Jerome Powell has said he needs ‘more good inflation data’ rather than ‘better data’ before cutting. This aligns with the December 2023 SEP showing core PCE falling 80bp in 2024, against 1.3ppt/year in 2022-23: the Fed expects US disinflation to enter its slower ‘last mile’. A slower disinflation trend makes interpreting inflation prints harder.
Specifically, the Fed wants:
- Disinflation in core services ex-housing to continue (Chart 2).
- More housing inflation progress.
- Slower wage growth.
- The above three points would offset the risk of goods price deflation ending due to geopolitical risks and deglobalization.
The Fed still expects a return to 2% inflation without recession. However, it also seems unlikely to cut when growth, currently estimated at 3.4% QoQ SAAR (Atlanta Fed nowcast), runs far above the FOMC’s long-term growth estimate at 1.8% (Chart 10). Finally, some FOMC members want to see the impact of easier financial conditions (Chart 5).
Key risks that could bring rate cuts forward include economic weaknesses or banking distress. Both seem unlikely. Furthermore, a marked decline in energy prices relative to Viresh’s expectation of a gentle increase to $85/barrel by Q2 2024 would likely see inflation slow as the energy-core inflation correlation remains significant (Chart 9). Faster disinflation would increase risks of the Fed undershooting its target and therefore bringing cuts forward.
The Fed has also recently indicated that it would discuss QT 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 was unlikely (Charts 3 and 4).
Finally, the Fed has announced that the Bank Term Funding Facility will end as scheduled in March and placed a floor under its costs to eliminate arbitrage between the BTFP and the Fed’s Term Deposit Facility (Chart 7).
Current Fed Macroeconomic Forecast
Recent FOMC Comments
Fed Unlikely to Cut in March
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.