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Fed meeting this week: what can we expect?
Macro

Fed meeting this week: what can we expect?

After the latest macroeconomic data, managers are beginning to question the effectiveness of the Fed’s hiking cycle. Has it been enough? What are the forecasts for the cutting cycle?
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Updated:

30 APR, 2024

By Jose Luis Palmer from RankiaPro Europe

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On Tuesday & Wednesday, we will have another Fed meeting. At this meeting, the Fed is expected to stick to its current stance and not make any interest rate cuts, keeping interest rates within the range of 5.25% to 5.5%. However, we will have to pay close attention to Jerome Powell's economic forecasts on Wednesday, as latest data may affect the Fed's forecast and therefore, the cutting path.
Here is a look at the international fund managers' outlook for the US central bank's April meeting.

Markets price in one and a half interest rate cuts

Gilles Moëc, Chief Economist at AXA IM

Among last week's abundant US data, the market focused directly on the higher than expected core inflation figure. Since last Friday, the market has priced in only one and a half interest rate cuts. The details of the PCE release brought no more relief than the headline figure: services inflation rose again, while manufactured goods inflation returned to positive territory, on a 3-month annualised basis, for the first time since June last year. We expect Jay Powell to make clear this week that the Fed is not in a position to cut rates soon. However, we still expect the Fed to cut rates this year (twice, starting in September). This is assuming that the first quarter GDP data, below potential growth for the first time in almost two years, points to the start of a lasting slowdown that would help restart the disinflation process, especially given the tightening of overall financial conditions, with 10 year yields returning to levels not seen since last autumn. The longer the Fed maintains its current tightening stance, the greater the likelihood that it will exert sufficient pressure on aggregate demand to produce the necessary reduction in inflation, especially if markets correctly transmit the Fed's signals.

However, another dose of "higher for longer" in the US has serious implications for the rest of the world. In the case of the eurozone, while the June rate cut already seems fairly consensual in the Governing Council, hawks may point to the risk of stoking imported inflation in the eurozone through currency depreciation if the ECB departs too far from the Fed. Last week, Fabio Panetta of the Banca d'Italia made a strong case for decoupling, pointing to the general tightening of financial conditions that a Federal Reserve on hold would cause in the rest of the world, and we discussed in some detail a paper Panetta referred to in his speech, which quantifies the spillover effects of US monetary policy. We agree with him that the optimal reaction of a central bank facing lower domestic inflationary pressure and challenging demand dynamics should be to counter US contagion by cutting policy rates. The Bank of Japan is already facing strong pressure on its exchange rate, which has fallen below the levels that had triggered an exchange rate intervention in 2022. However, the latest inflation data confirm Ueda's caution in normalising monetary policy.

The key to Fed policy is interest rate sensitivity.

Erik Weisman, Chief Economist and Portfolio Manager, MFS IM

At the end of 2018, the Fed raised rates to just 2.50%, which was enough to slow the economy sharply. In this rate cycle, however, the Fed has raised rates by 500 basis points, and yet the economy continues to move at a brisk pace. This is due to the following:

  • The economy is now less sensitive to interest rates because fundamental conditions have changed. If that is the case, the Fed may need to raise rates further.
  • The economy remains rate sensitive, but real effective rates are not as high and overall financial conditions remain accommodative. If so, the Fed needs to raise rates gradually until monetary policy is sufficiently tight.
  • The economy is less sensitive to rates now, but only because of the pandemic stimulus. If true, the Fed may simply need more time for current rates to take effect.

The bottom line is that the Fed is in the unenviable position of having to sort all this out without much guidance.

Markets price in one and a half interest rate cuts

Christian Scherrmann, US economist at DWS

The disinflationary process, although ongoing, has not lived up to expectations in recent months. And while the expectation of lower rates may have helped to boost economic activity (and prices) in the past, another factor may have had an even greater impact. The latest migration data suggest that inflows may have been significantly higher than previously assumed. While an increase in population inevitably supports aggregate demand, and perhaps also prices in the short run, it does not necessarily lead to higher inflation in the medium term. A larger labour supply could ease labour market tightness and thus support expectations of lower wage increases in the future. Eventually, this provides a rather positive outlook for disinflation. We continue to expect the disinflationary process to continue, albeit with greater volatility than expected. These developments continue to support the lowering of policy rates, albeit somewhat later than initially projected.

This brings us to the main theme for the May FOMC (Federal Open Market Committee) meeting: hitting the snooze button depending on the data. Central bankers have already indicated that they are in no hurry to tighten rates and that the current stance of monetary policy is considered tight enough. To restore neutrality in their guidance, we believe that the "fight inflation first" narrative requires some updating. This could be achieved by reminding markets that if inflation rates were to rise again, another round of rate hikes could be on the table. While interest rate hikes are certainly not our base case scenario, we believe that central bankers, with this hawkish attitude, are buying the necessary time for the faltering disinflation process to move forward. Finally, we anticipate receiving some details on a Fed balance sheet reduction (QT), as central bankers should have discussed this topic at length by now.

The road to lowering rates narrows

François Rimeu, senior estrategist at La Française

We expect the Fed to hold the federal funds target rate steady at its meeting this week. We expect Fed Chairman Powell to indicate that as long as the economy remains resilient, the Fed will take time to assess the trajectory of inflation and ensure that it returns sustainably to its 2% target. As a result, the Committee will maintain its tightening stance for longer than previously thought, without ruling out any hard-line decisions if necessary, even if this is not its baseline scenario. Here are our expectations for this week:

  • The Federal Reserve will leave interest rates unchanged at a target range of 5.25% to 5.50%.
  • Fed Chairman Powell will indicate that the policy stance is appropriate given continued US economic strength combined with higher than expected inflation.
  • Powell is likely to argue that the US central bank will consider fewer interest rate cuts this year than the three cuts expected by most Fed officials in March. Accordingly, he will stress that the number, timing and frequency will depend on inflation and labour market data.
  • The Fed is expected to confirm its plan on the future of its balance sheet reduction by cutting the Treasury limit from $60 billion to $30 billion a month, probably in June.

All in all, the Fed should respond with a more hawkish stance to unexpectedly strong inflation data in March, for the third month in a row. This backdrop will force the FOMC to adopt a wait-and-see approach, thereby postponing the start of the easing cycle. We believe that this week's meeting will focus on how long US interest rates will remain high and the possibility of another rate hike, which could push US interest rates higher and translate into a strengthening dollar.

Credibility on the line

Kevin Thozet, a member of the investment committee at Carmignac

The window of opportunity for the Federal Reserve (Fed) to cut rates this summer is narrowing as economic data continues to reveal the strength of the US economy. Thus, Jerome Powell's credibility is likely to be called into question once again this week.

Powell tried his luck last December when he signalled that monetary tightening had reached its peak, seeking to preserve the possibility of a soft landing for the US economy. And by doing so, redeeming his error of 2022, when he called inflation transitory. Undoubtedly, he believes a soft landing represents the only way to preserve the autonomy of the institution he serves or the neutrality of his position. A hard landing of the US economy would favour Trump's re-election, which in turn favours the unitary executive theory, which advocates the removal of independence of federal agencies, including the Fed.

After the "seasonal noise" aimed at justifying the strength of the labour market at the start of the year, and a "bump in the road" to look through the strength of inflation prints in February/March, the big question is will the Fed finally acknowledge the persistence of inflation? Even if that means the risk of a hard landing increases. 

In any case, the Fed's data dependence and the fact that both Powell and Waller have indicated that inflation data should be below 0.25% on month-on-month basis by the summer before an interest rate cut is made - and we are still a long way from that - suggest that the Fed will not lower its policy rates before the elections

With no further publication on the expected future path of interest rates or growth and inflation projections, the focus of tomorrow’s meeting will be the evolution of the Fed’s balance sheet. The rate of divestment from sovereign bonds is expected to be halved (from $60 billion to $30 billion on a monthly basis). Having shed $1.5 trillion already, the Fed is expected to reduce the pace of normalisation of its balance sheet, fearing that this will also have too much of a restrictive impact.

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