Kicking the can down the road

Stephen Dover, CFA, Head of Franklin Templeton Institute

Rick Polsinello, CIMA Senior Market Strategist, Franklin Templeton Institute

As was widely expected, the Federal Reserve (Fed) decided to leave the fed funds rate unchanged at its January 31 Federal Open Market Committee (FOMC) meeting, with members voting unanimously to maintain the target rate range at 5.25% to 5.50%.

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.

Maybe more important than what was said in the policy statement and at Powell’s press conference was what was not included. First, the statement removed any mention of potentially tightening (“or firming”) of monetary policy in the future via interest-rate increases. Also no longer included were mentions of Fed policymakers’ concerns about the impact of tightening credit conditions. Finally, also dropped from the statement was a prior mention of their accounting for prior tightening and the monetary policy lags.

Powell stressed that the Fed would continue to be hyper-focused on its dual mandates of price stability and maximum employment. Remember that the latest core Personal Consumption Expenditures (PCE) reading—the Fed’s preferred gauge of inflation—was 2.9%, with the headline (including food and energy prices) coming in at 2.6%, both levels that have been trending downward toward the Fed’s stated inflation target of 2%. The most memorable line from Powell’s press conference was when he said 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.” This appears to effectively take a March rate cut off the table. Powell went further to say that although inflation has eased, it remains elevated. He did, however, admit that the risks to achieving the Fed’s dual mandate have been “moving into better balance.”

On the labor market, the US unemployment rate remains at 3.7%, off historic lows but still lower than the Fed would like to see, according to Powell, who stated that jobs gains “moderated but remain strong.” He acknowledged that the labor-force participation rate has improved but that demand still far exceeds supply, and that wage inflation is important in a tight labor market such as today.

Finally, he stressed that the Fed would continue to be highly data dependent in its monetary-policy decisions and that economic activity has expanded at a solid pace, with gross domestic product coming in well over 3% (versus his prior statement seven weeks earlier, which indicated that economic activity was slowing).

Markets did not respond well to this news, with the Dow Jones Industrial Average dropping 300 points after Powell’s press conference. The market’s expectations for rate cuts in 2024 (in both the timing and magnitude) have been well above the Fed’s latest “dot plot” projections from mid-December. Market consensus was expecting six rate cuts in 2024, while the median FOMC member was expecting only three cuts? this year. The S&P 500 Index ended the day of the meeting 1.6% lower, the Nasdaq Index fell 2.2% and the Russell 2000 Index was down 2.4%. The news was largely priced into the short end of the yield curve already; however, rates rallied by double digits across the intermediate-to-long part of US yield curve, with five- and 10-year Treasury notes ending the day yielding less than 4%.

Anyone else hear that familiar sound of a can being kicked down the road?

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