The Fed Holds Rates Steady and Remains Patient

May 1, 2024 Kathy Jones
As expected, the Federal Reserve kept its policy rate unchanged at the May meeting, but left the door open to rate cuts later this year if inflation declines.

As expected, the Federal Reserve kept the target range for the federal funds rate at 5.25% to 5.50% at the May meeting of the Federal Open Market Committee (FOMC). Citing recent elevated inflation readings, the statement accompanying the announcement indicated that FOMC members consider it too early for rate cuts. Meanwhile, the Fed is planning to "taper" its quantitative tightening program in June by reducing the dollar amount of Treasuries it allows to mature without reinvestment.

Sticky inflation is a risk

There were a few notable changes to the Fed's statement from the previous meeting. A sentence was added acknowledging "lack of progress" on inflation in "recent months." That stickiness in inflation in the first quarter of this year is likely to keep Fed policy on hold until later in the year. The committee needs to see a resumption in the decline in inflation to feel confident enough to cut rates.

Inflation has fallen from its peak

Chart shows the Personal Consumption Expenditures, or PCE, Price Index and the "core" PCE Price Index dating back to March 2014. The core index excludes food and energy prices, which tend to be volatile. As of March 31, 2024, the PCE growth rate was 2.7% and the core PCE growth rate was 2.8%.

Source: Bloomberg, monthly data as of 3/31/2024.

PCE: Personal Consumption Expenditures Price Index (PCE DEFY Index), Core PCE: Personal Consumption Expenditures: All Items Less Food & Energy (PCE CYOY Index), percent change, year over year. Personal Consumption Expenditures (PCE) is a measure of consumer spending. Core PCE excludes food and energy prices, which tend to be more volatile.

The Fed's view of the economy is nearly unchanged, with the statement noting that the pace of economic growth is solid and job gains have been strong. However, Fed officials changed the wording describing progress toward balancing its two mandates—inflation and full employment—into the past tense. It noted that the risks to achieving its dual mandate of full employment and low inflation "have moved toward better balance over the past year" instead of "are moving." That might seem like a minor change, but it highlights how much the recent stalling in inflation's drop is seen as a risk for Fed policy.

Tapering quantitative tightening

The Fed also announced that it is going to slow down the pace of balance sheet reduction. Quantitative tightening is the process where the Fed allows bonds held on its balance sheet to mature without reinvesting the principal. The Fed will reduce the cap on maturing Treasuries from $60 billion per month to $25 billion. The cap on mortgage-backed securities will stay the same at $35 billion, but proceeds of maturing bonds will be reinvested into Treasuries.

The announcement is not a big surprise, as the Fed had signaled it was reviewing the program and would likely slow it down due to concerns about the need to maintain liquidity in the financial system. It isn't likely to have much impact on the market. The Fed's caps were not reached most months during the program. Even with tapering the pace, the Fed's balance sheet should continue to fall. It isn't seen as a policy move, but rather a way to address liquidity concerns.

The Fed's balance sheet

Chart shows the Fed's holdings of Treasury bills, notes and bonds, as well as Treasury Inflation-Protected Securities and mortgage-backed securities dating back to 2009. The Fed's balance sheet has shrunk since 2022 as the Fed implemented quantitative tightening.

Source: Bloomberg, weekly data as of 5/1/2024.

Reserve Balance Wednesday Close for Treasury Bills, Treasury Notes, Treasury Bonds, Treasury Inflation Protected Securities, and Mortgage-Backed Securities.

In the post-meeting press conference, Fed Chair Jerome Powell addressed a few questions that have weighed on the bond market. He indicated that the committee does believe policy is "restrictive" at current levels despite the ongoing resilience in the economy. He also said that he didn't expect that the next move would be a rate hike. It hasn't been ruled out, but he indicated it isn't likely.

Overall, the Fed's policy remains on hold. Powell described the Fed's stance as "patient." We still believe there is a potential for rate cuts in the second half of the year. However, the outlook depends on inflation resuming its declining trend. For now, the Fed's policy will continue to be one of "higher for longer," but the overall plan to reduce rates longer term is still intact.

The immediate reaction in the markets was a rally in bond prices. Treasury yields fell for all maturities. Markets had been concerned that the Fed might rule out rate cuts this year or even signal a potential rate hike. However, the message was consistent with the potential for one to two cuts of 25 basis points (or 0.25%) each in the federal funds rate in 2024.