Quick Thoughts: Fed hawks will fly lower—eventually

Originally published in Stephen Dover’s LinkedIn Newsletter, Global Market Perspectives. Follow Stephen Dover on LinkedIn where he posts his thoughts and comments as well as his Global Market Perspectives newsletter.

As was widely expected, the Federal Reserve (Fed) decided to again leave the fed funds rate unchanged at the Federal Open Market Committee (FOMC) meeting that concluded on May 1, with members voting to maintain the target rate range at 5.25% to 5.50%. However, the central bank did tweak monetary policy through reducing the balance sheet runoff (or quantitative tightening) from US$95 billion per month to US$60 billion. Agency mortgage-backed securities will continue to run off at US$35 billion per month, and the US Treasury runoff will go from US$60 billion per month to US$25 billion. The Fed’s balance sheet is still US$7 trillion, though, after nearly doubling in size to US$9 trillion in response to issues the pandemic had created.

Although there were no huge surprises coming out of the meeting, the subsequent statement and press conference from Fed Chair Jerome Powell was interesting nonetheless and may have provided hints at how the FOMC is thinking about future monetary policy changes.

Its last meeting in late March was a quarterly FOMC meeting, so the Fed released an updated “dot plot” (formally named The Summary of Economic Projections or SEP) that still showed that the median dot was three cuts with minimum increments of 25 basis points by the end of 2024. However, it was only one dot away from showing the median as two cuts.

Since then, there has been some significant repricing in the fed funds futures market,¹ which now indicates that the six or so cuts expected at the beginning of this year are now more like only one or two cuts.

There was some angst in the market—due to some recent data releases showing inflation a bit stickier than anticipated—that the Fed might mention the possibility of a hike being needed or cuts being pushed out into 2025. This did not happen, which the market seemed to applaud. However, Fed Chair Powell did say that the “committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably towards the 2% target.”

It is worth remembering that despite the core Personal Consumption Expenditures Price Index (the Fed’s preferred inflation gauge) spiking up to 5.6% at the height of the pandemic, our latest reading is just half of that figure at 2.8%. Also, Powell repeated that although it hasn’t come down as quickly as expected during the first four months of the year, overall the longer-term trajectory is still downward, and the Fed’s base case is for an eventual return to their target of 2%.

Finally, the Fed stressed that it would continue to be highly data dependent in its monetary policy decisions and that economic activity has continued to expand at a solid pace, inflation has eased but remains elevated, and that the second part of its dual mandate, maximum employment, looks on track with unemployment still below 4%.

The doves will come eventually—but first we will have to wait and see these hawks start to fly a bit lower.