Fed signals rate cut, but not yet in March

The Fed left the target range for the fed funds unchanged at today's meeting.

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Bernd Weidensteiner, Dr. Christoph Balz

Commerzbank Economic Research

February 1 2024

However, the US central bank has changed its forward guidance and removed the reference to possible further rate hikes. Instead, it is opening the door to rate cuts, even if it first wants to gain more certainty that inflation has really been beaten. That said, a rate cut already at the next meeting in March is unlikely.

The decision: As expected, the Fed has left its key interest rates unchanged. The fed funds target range thus remains at 5.25%-5.50%.

The Fed has adjusted its forward guidance; this was also to be expected: The Fed judges that the risks to achieving its inflation and employment target are now better balanced. The risk of excessive inflation is therefore no longer as dominant as it has been in recent years. Consequently, the Fed has also removed the previous bias towards possibly necessary further rate hikes from the statement. Instead, it now explicitly refers to the conditions for interest rate cuts. "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 percent.". For the time being, it will continue to reduce its securities portfolio at an undiminished pace (i.e. up to 80 billion dollars per month). Today's decisions were unanimous.

Press conference: Fed Chairman Powell noted that the inflation data of the last six months had been positive (in the six months to December, both total and core inflation were at or slightly below 2% annualized). The question now is whether this data gives a true signal that the inflation rate will actually reach the 2% target on a sustained basis. Although the Fed has become more confident in this respect, it is not yet confident enough to already embark on rate cuts.

Powell tried to dampen expectations of rapid interest rate cuts. From today's perspective, Powell considers a cut at the March meeting to be unlikely; this is not the baseline scenario. The Fed obviously wants to wait for further data. In doing so, the Fed also wants to avoid being surprised by the economy again. Once again, the Fed's concerns about a premature rate cut have become clear. The central bank could then find itself in the embarrassing situation of having to change direction and raise key interest rates again.

Powell emphasized that the Fed is not looking to weaken the economy and does not want to see a weaker labor market. This is a noticeable shift in emphasis. Last year, the Fed was still assuming that the economy would have to cool down significantly in order to combat high inflation. Now, however, inflation has fallen without the economy losing momentum.

According to Powell, the Fed's balance sheet was discussed again at the meeting. At the next meeting in March, there will be an intensive discussion on the further reduction of the Fed's securities portfolio.

Our interpretation: It has been clear for some time that the Fed will be looking at rate cuts in 2024. The projections updated by Fed policymakers at the last meeting in December ultimately envisage three rate cuts by the end of the year. All that remains to be clarified is the exact timing. However, the relatively robust economic data recently has not put the central bank under any immediate pressure to act. There is still time to wait for further data in order to be really sure of a victory over inflation. We still consider our forecast of an initial cut of 25 basis points in May – i.e. at the meeting after next – to be plausible. We expect five further cuts of the same magnitude by the end of the year.