After the FOMC’s January 2024 meeting, their statement made clear additional rate hikes were off the table, barring a dramatic change in the economy’s current direction. Based on indications the Fed made in late 2023,1 markets began to price in a series of fed fund rate cuts for 2024, with many anticipating that such cuts would begin as soon as March. After January’s FOMC meeting, the timing of a start date for rate cuts seems less certain. “Inflation remains a bit sticky and the Fed realizes that once they start with rate cuts, it is hard to stop doing so in future meetings,” says Eric Freedman, chief investment officer at U.S. Bank Wealth Management.
In an official release following January’s FOMC meeting, it was stated 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 percent.”2 Inflation, as measured by the Consumer Price Index, stood at 3.4% in December.3 In the same month, a closely watched Fed inflation measure, the core personal consumption expenditures (PCE) index, was 2.9% higher than the previous year.4
Market reacts to Fed policy moves
Immediately after the December FOMC meeting, when the Fed gave its first official indication that rate cuts were likely in 2024,1 stocks rallied, and Treasury bond yields fell. By mid-January, the benchmark S&P 500 stock index reached new all-time highs. The 10-year U.S. Treasury note yield dropped below 4%, its lowest level since July 2023.
“By the end of January 2024, the markets were walking back Fed rate cut expectations they priced in during the closing weeks of 2023,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “The economic data, such as real Gross Domestic Product growth (up 2.5% in 2023),4 continues to look fairly strong.” Haworth says the markets were pricing in five or more Fed rate cuts in 2024, even though the Fed, in a summary released after its December 2023 meeting indicate that only three rate cuts were likely.
While few anticipated a fed funds rate cut to occur as early as January, markets initially priced in the first rate cut for the Fed’s meeting on March 19-20, 2024. When asked, after the FOMC’s January meeting, about the possibility of the Fed cutting rates in March, Fed Chairman Jerome Powell stated, “I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting to identify March as the time to do that.”5 Powell did, however, confirm earlier Fed projections that rate cuts would begin at some point in 2024.
Inflation’s stickiness
A primary Fed focus since 2022 was to temper the rapid rise in the cost of living. Headline inflation, as measured by the Consumer Price Index (CPI), peaked at 9.1% for the 12-month period ending in June 2022, but dropped significantly since.3 “The Fed has had opportunities to change its 2% annual inflation target, and it hasn’t done so,” says Freedman. “Despite its progress since early 2022, current inflation is still above the Fed’s target rate. But we think the Fed will have to start cutting rates before inflation drops to the 2% level.” Freedman says current rates may not be sustainable at their current high levels before they start causing damage to the pace of economic growth.
Haworth agrees, noting that the Fed may eventually feel increasing pressure to begin cutting rates. “Now that inflation has dropped, the current fed funds rate is higher on a real (after-inflation) basis than it was back when inflation was 9%.” Haworth adds that “at some point, the Fed may feel it’s being tougher on the economy than it really needs to be.”
Haworth also believes the Fed may need to consider scaling back its “quantitative tightening” strategy. This approach has seen the Fed reduce its bond holdings since mid-2022. “The Fed may determine it needs to help maintain some liquidity in fixed income markets by slowing or stopping its balance sheet reduction for a period of time,” says Haworth. “This might be important in an environment where the U.S. Treasury needs to increase its debt issuance to keep pace with an expanding debt load.” However, in January, the FOMC choose to continue trimming the Fed’s balance sheet and gave no indication a change was likely in coming meetings.
Despite significant Fed monetary tightening, the U.S. economy proved resilient. In his January 2024 comments, Powell stated, “Recent indicators suggest that the growth of economic activity has been expanding at a solid pace.” Powell added, “As labor market tightness has eased and progress on inflation has continued, the risks to achieving our employment and inflation goals are moving into better balance.”6
Role of the Fed
Congress’ mandate for the Fed is to maintain price stability (manage inflation); promote maximum sustainable employment (low unemployment); and provide for moderate, long-term interest rates. Fed monetary policy influences the cost of many forms of consumer debt such as mortgages, credit cards and automobile loans. While Chair Powell receives much of the attention, the FOMC establishes Fed monetary policy, setting the fed funds target rate and the buying and selling of securities.