Fed Drops Tightening Bias, but No Easing Signaled

January 31, 2024 Liz Ann Sonders
As expected, the Fed held rates steady in January, but importantly downplayed the likelihood that rate cuts will start as soon as March.

No change in rates at today's Federal Open Market Committee (FOMC) meeting, which was expected. It was a unanimous decision and represented the fourth consecutive meeting during which the Fed remained in pause mode. That keeps the fed funds rate in a range between 5.25% and 5.5%, with the most recent rate hike having been back in July 2023. In the FOMC statement, the Fed excluded its prior assertion that another rate hike was possible; instead suggesting a more balanced assessment of the policy path looking ahead.

"The Committee judges that the risks to achieving its employment and inflation goals are moving into better balance," the statement read. Per the policy outlook, the Fed was noncommittal: "In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks." Dropped from the December FOMC statement was the tightening bias: "In determining the extent of any additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments."

However, there was no expressed rush to move to easier policy. Instead, the statement noted 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 toward 2%" (emphasis mine). Within the statement, there was an adjustment of the assessment of the economy, now describing activity as "expanding at a solid pace."

Regarding the health of the financial system, the statement omitted a sentence from the December FOMC meeting about the "U.S. banking system [being] sound and resilient," and that "tighter financial and credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation." Instead, today's statement noted that the "economic outlook is uncertain, and the Committee remains highly attentive to inflation risks."

With regard to the Fed's balance sheet, the statement reiterated the current pace of reduction totaling as much as $95 billion per month via the combination of Treasuries and mortgage-backed securities. The Committee also reaffirmed its long-term monetary policy strategy, including the commitment to a 2% (average) inflation target.

In the immediate aftermath of the release of the FOMC statement, the probability of a March rate cut dropped from more than 70% at one point today to 45% immediately after the announcement and then settled around 47% as of this writing (per the CME FedWatch Tool). Stocks sold off initially, rebounded, and then sold off further as Powell pushed back on cutting rates soon. Bond yields rose off their lows of the day.

Presser highlights

As usual, these highlights are from the first 30 minutes of the press conference with Fed Chair Jerome Powell, in the interest of getting this report in the publishing queue in a timely manner.

  • Powell and his colleagues are focused on their "dual mandate," and that inflation has eased from highs without a significant increase in the unemployment rate; but also reiterated that the path forward is "uncertain."
  • There was a reiteration that the Fed has moved rates "well into restrictive territory" and that the "labor market remains tight."
  • The Fed is well aware of the "pain" that inflation poses on households and that "high prices hit lower income workers hardest."
  • Without making any commitments, Powell did say it would be "appropriate to dial back [rates] at some point this year" but that the Fed will continue to make decisions "meeting-by-meeting."
  • Powell mentioned that rates are likely at their peak for this cycle, which is consistent with the removal of the tightening bias in the statement.
  • The Fed is "looking for a continuation of the good data we've been seeing," with Powell adding that the Fed is confident, but wants to have "even more confidence."
  • Although Powell said the Fed cares about "aggregate" inflation and not any index's composition, he noted that it's reasonable to assume that goods deflation will flatten out, meaning that services would need to step up and contribute more to disinflation.
  • Attention-getter: "Almost every participant on the Committee does believe that it will be appropriate to reduce rates." Almost? Hmmm. That might have been in reference to Dallas Fed President Lorie Logan, who said earlier this year that another rate hike should not be taken off the table. Perhaps that's why Powell mentioned that there is a "healthy disparity of views" on the Committee.
  • Powell rejected the notion that the increase in real (inflation-adjusted) rates does not necessarily mean the Fed needs to cut rates, mentioning the Fed is in "risk management mode" in the interest of not moving too soon.
  • Asked about the statement's mention of inflation being "elevated," Powell said the core PCE (the Fed's preferred measure) is at 2.9% year-over-year—above 2%, but "way down" from where it was.
  • Key comments: "We're not at a place" of detailing rate cut plans and that the Fed is "not declaring victory."

In sum

Likely most in focus for Fed watchers was the dropping of the tightening bias; along with the fact that, about 35 minutes into the question-and-answer session, Powell mentioned that it is unlikely the Fed will cut rates in March. The Fed has confidence in its policy decisions but needs to see a continuation of better data on inflation. Notably, the Fed does not see stronger growth as a problem in and of itself; but if the labor market were to weaken, that would argue for starting rate cuts sooner. Given the Fed's meeting-to-meeting data dependency, we expect volatility around rate cut probabilities to persist.

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