Hopes Dim for Rate Cuts This Year

Key Takeaways

• The Federal Reserve’s Federal Open Market Committee (FOMC) continued to hold the federal funds target rate range at a 23-year high of 5.25% to 5.50% due to recent inflation data.
• Market expectations for the FOMC to hold their benchmark rate steady started the meeting at 97%, an increase from after their March meeting, where expectations were at 89%.
• The Federal Reserve decided to begin reducing their roll off from $95 billion to $60 billion in assets, lowering the redemption cap from $60 billion in Treasuries to just $25 billion, while continuing to allow $35 billion in agency mortgage-backed securities to mature month-over-month.  
•  While markets appear to be pricing in a September cut by the Fed, the odds stand at a coin flip as expectations currently sit at 50% for a 25-basis-point cut.

At their May meeting, Federal Open Market Committee (FOMC) members unanimously agreed to leave the fed funds rate range unchanged at 5.25% to 5.50%. With little hope for a rate cut at the first meeting of the second quarter, investors were instead focused on the committee’s comments around the current resilience of inflation, as well as the committee’s plans for the balance sheet. There was little change to the Fed’s statement from March, as the committee reiterated their focus on getting inflation back on track to their 2% target. While the Fed did not change its projection for three rate cuts this year in its March update of Summary of Economic Projections (SEP), despite the hotter-than-expected monthly inflation numbers reported for January and February, Fed Chair Jerome Powell noted that there will likely be “bumps in the road.” If the three rate cuts are conditioned on achieving the committee’s 2% target, the Fed has no reason to pull back on the number of rate cuts just yet unless the committee sees the first-quarter spike in inflation as ending the disinflationary trend.

With March consumer price index (CPI) inflation surprising to the upside, it became apparent that the January and February bump in inflation also extended to March. This was further reinforced by the March personal consumption expenditures (PCE) inflation print, released last week, which showed that core PCE inflation firmed to 0.32% month-over-month (2.8% year-over-year), along with upward revisions to the January and February estimates. The inflation prints for the first three months of the year likely lowered the FOMC's confidence that inflation is moving sustainably toward 2%. If anything, inflation appears to have re-accelerated in Q1, with the March core PCE estimates placing the three-month and six-month annualized rates at 4.4% and 3.0% respectively, compared with under 2% run-rates in December. 

In addition, the Fed has decided to begin reducing their roll off from $95 billion to $60 billion in assets of its roughly $7.7 trillion balance sheet. The committee also decided to reduce the redemption cap from $60 billion in Treasuries to just $25 billion and continue with $35 billion in agency mortgage-backed securities to mature month-over-month.

Below are the Fed statement language changes from March:

After the Fed announcement, the 10-year Treasury ended the day lower and finished at 4.63%; short and long rates were also lower for the day.

10-Year Treasury Yield over the Past 12 Months

In Conclusion

The first FOMC meeting of 2Q24 met market expectations by again keeping interest rates steady, as much of the focus was on how the Fed would respond to the stickiness and rebound of inflation. While it was no surprise that the Fed reiterated a higher-for-longer approach, market participants felt that the committee’s comments adequately addressed there bound in inflation and did not cause the committee to move off the potential idea of at least one rate cut in 2024. While the recent inflation prints likely caused a lot of baseline calls to move to just one 25-basis-point rate cut this year, investor flows were well ahead of this week’s Fed meeting, which caused little knee jerk reaction across markets post press conference. As markets look to be pricing in close to a 50% chance of a first rate cut in September, this is likely predicated on core PCE inflation slowing to around 0.20% month-over-month by June and July and staying near there through August. If that base case does play out, it would imply notable progress in the three-month and six-month seasonally adjusted annual rate measures of core PCE inflation by the September meeting and set core PCE inflation on track to reach 2.9%, 0.3 percentage points higher than in the March SEP. When you include expectations that could point to a gradual deceleration in aggregate demand, this in total would open the door for a potential September cut. However, if inflation continues stronger than expected, investors should shift their expectation of a first rate cut to December, but we will have to wait and see what spring and summer bring for inflation.

The Dow Jones Industrial Average and S&P 500 Index returned +0.23% and -0.34% for the day and Treasury yields on both the long and front end were lower, with the 10-year and 2-year Treasury spread decreasing to -0.33%. While expectations started the final day of the FOMC meeting at 9.6% for a cut at the next meeting, per the CME Groups Fedwatch Tool, this should be no surprise to markets as the Fed continues to remain data dependent and inflation remains sticky. But for the time being, it is very clear that it would take a significant event for the Fed to even consider a potential hike in rates and that the path going forward is more likely lower than higher. While the higher-for-longer song continues to play, investors should try to take advantage of these record high interest rates before they become a thing of the past.

Definitions:

One basis point is equal to 0.01%.

The Dow Jones Industrial Average index (DJIA) tracks the share price of the top 30 large, publicly-owned U.S. companies which is often used as an indicator of the overall condition of the U.S. stock market.

Gross Domestic Product (GDP) is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period.

Personal Consumption Expenditures (PCE) refers to a measure imputed household expenditures defined for a period of time.

The S&P 500 index is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the U.S. stock market.

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