The Fed Is Not Making the Cut ... Yet

Key Takeaways

• At its January meeting, the Federal Reserve’s Federal Open Market Committee (FOMC) held the federal funds target rate range at a 23-year high of 5.25% to 5.50%.
• Fed Chair Jerome Powell indicated rate cuts are not imminent due to inflation worries.
• The FOMC also added language in its January statement about interest-rate cuts, stating, “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.”
• Market expectations for the FOMC to hold its benchmark rate steady at the current range started the meeting at 97.9%, an 18.8% increase from the start of 2024.
• At the end of the FOMC meeting, market expectations for a rate cut in March plummeted from 73.4% at the start of January to 34.5%.
• The Fed painted a brighter picture of the U.S. economy compared to its December outlook.

At their January meeting, Federal Open Market Committee (FOMC) members unanimously agreed to leave the fed funds rate range unchanged at 5.25% to 5.50%. With inflation nearing the Fed’s 2% long-term target but the economy still growing, the central bank’s decision to keep rates steady for the fourth consecutive time was broadly expected. Estimates for rate cuts to begin at the Fed’s first meeting of 2024 started the year at 82.4%, while almost 20% of the market thought a rate cut was warranted due to the improvement in the drop in inflation.

The Fed painted a much brighter picture of the U.S. economy compared to its December outlook but also underscored it was in no rush to cut the fed funds rate.

“It will likely be appropriate to begin dialing back policy restraint at some point this year, but the economy has surprised forecasters in many ways since the pandemic, and ongoing progress toward our 2% inflation objective is not assured,” Fed Chair Jerome Powell said after the meeting.

With inflation near the Fed’s 2% long-term target and recession fears at bay for now, the economy looks to be on course for a soft landing. Equity and bond markets have done well since the Fed entered this holding pattern, it has also led to the question for central bank officials about the pressures on real interest rates and when to lower nominal interest rates to prevent real rates from rising further.

In addition, the Fed decided to continue to allow up to $95 billion in assets ($60 billion in Treasury securities and $35 billion in agency-backed securities) to roll off its roughly $7.7 trillion balance sheet each month, but the current pace will be debated at the central bank’s March meeting.

Below are the Fed statement language changes from December:

Market Reaction

After the Fed announcement, the 10-year Treasury ended the day lower and finished at 3.99%; short and long rates were also lower for the day.

Equity markets closed in negative territory on the final day of the FOMC meeting, as the committee made it clear that it was in no rush to cut the benchmark rate. While Chair Powell stated the committee would move to cut rates should labor markets come under pressure or reductions in inflation appear to be sustainable, that was not enough to appease equity markets. Both the Dow Jones Industrial Average and S&P 500 Index finished down -0.82% and -1.61%, respectively, for the day.

In Conclusion

The first FOMC meeting of the year met market expectations by again keeping interest rates steady, but the Fed’s rhetoric also provided a keen reminder of the central bank’s determination to drive inflation back to its 2% target. While it appeared that many market participants expected the Fed to be closer to making its first cut in the fed funds rate since the hiking-cycle began, the committee made it clear rate cuts won’t begin until the data supports the recent decrease in inflation is sustainable.

So, while investors have seen risk rewarded since the last time the Fed met in December (high-yield bonds, represented by Bloomberg Corporate High Yield; bank loans, represented by Morningstar LSTA; and equities, represented by Russell 3000 have been up 2.37%, 1.71% and 4.58%, respectively), the economic optimism shown by Chair Powell seemed to be overshadowed in investor’s eyes by his and the committee’s comments about the sustainability of the reduction in inflation. This also seemed to potentially signal to investors that they may need to reassess expectations of how higher-for-longer might impact company financials given a more tepid stance by the Fed on the state of inflation. But time will tell if investors remember what was said today or if they will take an out-of-sight, out-of-mind approach until the Fed’s next meeting in March.

This information is presented for informational purposes only. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole investment making decision. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed. The opinions expressed herein are based on current market conditions and are subject to change without notice.