• Blunt assessment: “the economic outlook is uncertain.”
• No cuts until “more confident of inflation reaching 2%.”
• Inflation remains “elevated.”

Set the stage

Today, the FOMC left short-term rates unchanged for the fourth meeting in a row. The Committee used the press release to remove the bias toward higher rates and set the stage for future rate reductions. They also tried to tone down excitement for imminent rate cuts. No word in the press release as to whether the Quantitative Easing program would be changed.

Rates

The press release shows the Committee moved from a tightening bias to neutral. The sentence, “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%,” is all but an outright admission that the next move, someday, is lower.

The next question is: When will the first cut happen? On average, the time between the last hike and the first cut is around 11 months. From last July to May sounds about right. Futures markets, who have consistently bet wrong on cut timing, are pushing for May 1 or, at worst, June 12.

Regardless of the time between Fed rate actions, the Fed historically has not reduced short-term rates until the annualized growth rate of nominal gross domestic product falls below the Fed Funds rate. Nominal GDP is reported by the Commerce Department in actual dollars. Most readers are familiar with “real” GDP, which is just nominal GDP minus inflation. We are not going to get into a debate over which inflation rate to use in the analysis. We would point out that nominal GDP grew last quarter at a 5.8% annual rate. With Fed Funds averaging 5.33% right now, that test has not been met. Waiting for the nominal GDP rate to fall below Fed Funds implies that the Committee is waiting for the long-expected slowdown in economic growth.

Economic Outlook

Speaking of growth, the economy continues to roll along in second gear. Our clients give us a wide range of feedback on activity, ranging from “business is fine” to “we are worried” about the next six months. On the whole, our anecdotal evidence suggests the economy is not doing quite as well as official pronouncements suggest, but nowhere near recession or Fed cutting territory.

Quantitative Tightening

Bond bulls were hopeful the press release would suggest or even outline steps to reduce its QT program. Remember, this is the program to buy fewer Treasury and mortgage bonds each month. In its current form, the program has reduced the Fed’s balance sheet by nearly $1 trillion. The balance sheet traditionally sits near the level of currency in circulation, currently around $4.5 trillion. At $7-plus trillion, the Fed’s QT program has at least a couple more years to run to return the balance sheet to “normal.”

Heavy borrowing by the U.S. Treasury to fund Congressional spending has caused money market funds to purchase higher-yielding Treasury Bills. Much of the liquidity or cash to buy these Bills was earning interest at the Fed’s Reverse Repurchase Program. That program has dropped in popularity as Bills pay a slightly higher yield. Later this year, we expect the Treasury to issue more long-term debt to fund deficit spending. This may require the Fed to scale back on its QT program in order to start buying more Treasury bonds. A lack of a large buyer would force yields higher due to rising Treasury bond supply. No new plans were announced in the press release. Powell did say that the Committee was considering different plans but did not elaborate.

Summary

Powell, in his press conference, said March would be too soon for a rate cut. May is the likely date of a first cut if the economy does slow. We still believe most of the cuts come after election day and into 2025.

Powell stated that the Committee would consider a big drop in inflation or job numbers as factors that may change that view. Given the administration’s spending plans this year to support the economy, we doubt there would be large changes in employment in the next few months.

We do find it notable that year-on from Silicon Valley, the Fed today removed language about bank stress. The Committee also removed the statement regarding the impact of tighter financial conditions on households and companies. Clearly, the Fed believes families and companies are adapting to higher interest rates.

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