Monetary Policy & Inflation | US
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Summary
- The Fed has turned hawkish as it remains concerned over inflation and growth trends and is having doubts on the transmission of policy tightening to the economy.
- Current polling could also be pushing the Fed toward a more hawkish stance to maintain policy optionality.
- I expect the median dot in the June SEP to show only one 2024 cut.
Market Implications
- I do not expect the Fed to cut in 2024, against the market expectations of 1.2 cuts by end-December.
Fed Turns More Hawkish
The Fed has turned more hawkish over the past two weeks, despite a slowdown in MoM core CPI (Table 1). The minutes showed the Fed turning less optimistic on supply side gains, less concerned by downside economic risks, and more concerned by risks the policy rate was not high enough.
The minutes stated, ‘Although monetary policy was seen as restrictive, many participants commented on their uncertainty about the degree of restrictiveness. These participants saw this uncertainty as coming from the possibility that high interest rates may be having smaller effects than in the past, that longer-run equilibrium interest rates may be higher than previously thought, or that the level of potential output may be lower than estimated.’ This aligns with data showing a poor transmission of Fed tightening to the real economy (Charts 13-16).
Most importantly, the minutes revealed FOMC discussion of a possible move to a tightening bias, ‘Various participants mentioned a willingness to tighten policy further should risks to inflation materialize in a way that such an action became appropriate.’
Data Does Not Add to Fed Confidence
This increased hawkishness came after a lower April CPI than in March, which reflects factors such as:
- The Fed does not react to single data points. Q1 inflation trends turned unfavorable enough that several months of data will be needed for the Fed to increase its confidence in disinflation resuming (Charts 2-6).
- Growth trends remain strong (Charts 7-10). Recent data, including S&P PMIs, durable goods orders, and consumer confidence, have exceeded market expectations.
Elections Approaching
Recent polls continue showing presidential candidate Donald Trump in pole position, with the Republicans very likely to gain the Senate and likely to keep the House. In such an instance Trump would likely implement policies that would raise inflation and possibly growth.
The Fed likely does not want to find itself with an easing bias following a Trump victory. The Fed also moves slowly – it cannot go straight to a neutral bias from three 2024 cuts. As a result, it is likely to gradually remove the three 2024 cuts pencilled in the March SEP. I expect the June SEP median dot to show only one cut.
I still expect no cut in 2024 and the market has moved closer to my view. It currently prices 1.2 cuts by end-December, against two cuts two weeks ago.
Current Fed Macroeconomic Forecast
Recent FOMC Comments
Disinflation Has Stalled
Growth Remains Above Trend
Fed Tightening Transmitting Poorly
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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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