Fed meeting this week: what can we expect?

Today, 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. However, we will have to pay close attention to Jerome Powell's economic forecasts on Wednesday.
Here is a look at the international fund managers' outlook for the US central bank's March meeting.

Axel Botte, Head of Market Strategy de Ostrum AM

In the US, growth should be around 2% in the first quarter, or even 2.3% according to the Atlanta Fed's GDP Nowcasting. However, household consumption of goods has softened somewhat. February's retail sales (+0.6%) failed to correct the 1.1% drop in spending recorded a month ago. Inflation was again above expectations at 3.2% in February. Housing cost inflation, and to be fair, services excluding energy inflation (5.2%), remains well above that of goods at around zero. This poses a dilemma for the Fed, whose confidence in the continuation of the disinflation process underpins the promise of rate cuts and it is fair to say that market expectations of Fed rate cuts have been the key to the broad-based rally in financial markets since last autumn. These inflation data could delay the start of the monetary cycle, or even raise the rate floor in the coming years.

James McCann, Chief Economist at abrdn

The Federal Reserve is concerned that the final leg of its fight against inflation may become an uphill struggle, and this year's CPI data will have only exacerbated these fears.

In this context, the US central bank will send a cautious message to the markets, acknowledging the progress made in reducing inflation, but warning that a further slowdown is needed to justify lowering interest rates.

The good news is that, despite the early 2024 setbacks, inflation should soften as we move through the first half of the year, setting the stage for a first Fed cut in June. Indeed, we expect the FOMC to continue to signal three cuts this year in its updated rate forecast this week, which would be consistent with this timetable. However, Chairman Powell will make it clear that if there are further disappointments on the inflation front, rates will need to stay higher for longer.

Flavio Carpenzano, Investment Director at Capital Group

The Fed's shift prompted a major rebalancing of the interest rate market: the market now expects rate cuts of more than 150 basis points (bps) in 2024, compared to the 75 bps cuts expected by the Fed. After the strong technical bid in the fourth quarter, the 10-year Treasury yield closed 2023 at the same level at which it started, 3.88%, and the slope of the yield curve steepened slightly.
The outlook for political and economic fundamentals, as well as valuations, favour positioning for a turn in the yield cycle. Positioning for an increase in the slope of the yield curve is one of the US interest rate team's favourite structural positions, while the overweight in duration has lost some attractiveness after the recent fall in yields.

The Federal Reserve is likely to cut the policy rate in 2024 in response to declining inflation, but the cuts could be sharper in the event of a recession. The team's forecast value framework indicates that the market undervalues potential rate cuts in 2024 if the economy eventually enters a recession. The Fed typically cuts the maximum interest rate by 20-50% in soft landing scenarios and by 75-100% in hard landing scenarios, implying that cuts of more than 150 bps from the current rate of 5.25-5.5% could occur in the event of a recession of any magnitude. Given the recent fall in yields, duration is relatively less attractive in this scenario than positioning for the steepening of the yield curve.

Positioning for a steepening curve remains a key structural position in investment portfolios, as it is unusual for yield curve inversion periods to be prolonged in time. The slope of the curve could steepen in the event of a recession. If growth remains strong, the slope could also steepen in a different scenario where the Fed simply opts for maintenance cuts and long-term yields rise. Technical factors also point to a potential steepening of the slope of the curve as increased supply coincides with reduced demand from foreign investors and banks. That gap may have to be filled by households, which tend to demand a higher term premium to invest.
Although the technical factors for US Treasury Inflation-Protected Securities (TIPS) are negative, the short-term market-implied inflation is markedly favourable, even compared to our expectations of a continued slowdown in inflation. TIPS offer an attractively priced hedge, which could provide protection against the potential steepening of the yield curve in the event of a reacceleration of inflation.

Paolo Zanghieri, senior economist at Generali AM

We review our forecast for the Fed and now expect only three 25 basis point rate cuts by 2024, starting in June. The risks are more or less balanced, but we caution that in the end the central bank is likely to ease by only 50 basis points. Our upward revision is due to both recent data and the tone of the Fed's communication.
Starting with the data, January's PCE data provided a sobering surprise, with services inflation, excluding housing, rebounding from 3.3% to 3.5% yoy. At the same time, the economy is showing signs of slowing, but seems far from collapsing.

After a very strong fourth quarter of 2023, first quarter forecasts point to a GDP expansion of close to 3% annualised, too optimistic in our view, but not pointing to a recession. Consumption remains the key driver, as strong real income is offsetting lower savings. We have revised up slightly to 2.4% the growth forecast for 2024, also thanks to strong continuity (1.3pp). Although job vacancies and layoffs have declined markedly in recent months, the labour market remains robust, as is also evidenced by the very low unemployment rate (3.9%). Based on this evidence, the FOMC successfully convinced markets that rate cuts could wait longer. Governor Waller explicitly stated that he needs to "see at least another couple of months of inflation data" to assess whether the worrisome January CPI data were just a one-off episode. Therefore, for the March meeting, the FOMC will not have sufficient evidence. However, for the meeting on 30 April and 1 May, the Fed will have first quarter data on consumer price index inflation and its preferred wage measure (the labour cost index), whose year-on-year growth should be in the 3-3.5% range that the Fed considers consistent with the 2% inflation target, paving the way for the June cut. We have flattened the rate path and expect by 2025 a cumulative easing of 125 basis points (five cuts) to 3.5% (upper bound), followed by two further cuts in early 2026, bringing the policy rate to 3%, our estimate of the neutral rate. Although our forecast for 2024 is very close, markets diverge significantly for the following years, with futures currently quoting between two and three cuts and only one in 2026. We expect core CPI inflation to stand at 2.1% by the end of 2025, which corresponds to headline CPI inflation of 2.2%.

Markets have markedly repriced inflation (see chart below). We recognise this upside risk, as the minimal rise in unemployment that we envisage in our forecasts (a peak of 4.1% at the end of this year) may dampen the slowdown in wages. In addition, the rebound in house prices is likely to translate into rising rents with the usual 3-4 quarter lag, which could slow disinflation in early 2025. We therefore see some upside risks to our forecasts.

Marco Giordano, Fixed Income Investments Director at Wellington Management

Rate cuts are delayed. We are now two and a half months into 2024 and it does not look like central banks are ready to make interest rate changes, or at least not as soon as markets thought in December. At the end of last year, investors were predicting that the first interest rate cut would come in the next few weeks, with the Federal Reserve leading the way. By the end of February, markets had ruled out three of the expected cuts, and now expect the Fed to start cutting policy rates in June at the earliest.