The Fed Holds Rates Steady and Remains Patient
As expected, the Federal Reserve kept the target range for the federal funds rate at 5.25% to 5.50% at the June meeting of the Federal Open Market Committee (FOMC). It reduced its median estimate for interest rate cuts of 25 basis points (or 0.25%) by the end of this year to one from three at the last meeting, but it was a very close call with roughly half of the members looking for two cuts.
The quarterly Summary of Economic Projections showed that the Fed expects inflation to remain elevated in the near term but anticipates it will fall in 2025, allowing for as many as four rate cuts. Notably, the long-run interest rate forecast moved up from a median estimate of 2.6% to 2.8%.
The FOMC's latest dot plot
Source: Bloomberg. FOMC DOT Plot as of June 12, 2024.
The Fed's confidence in sustaining low inflation "not there yet"
The Fed has indicated that it is waiting to initiate rate cuts until it is "confident" that inflation will reach its 2% target and remain low. Based on comments from Federal Reserve Chair Jerome Powell, the committee "is not there yet." He acknowledged recent progress on bringing inflation down, but apparently the committee wants to see a few more months of favorable readings to feel confident about cutting interest rates.
It was hard to align the economic estimates for elevated inflation and solid economic growth with the Fed's plans to cut rates. The explanation offered by Powell was that with policy currently restrictive, there is room to lower rates as a more stable inflation outlook is established. He cited the uncertainty created earlier in the year when inflation readings failed to show progress. Presumably, a few more months of good inflation readings would solidify the Fed's confidence that inflation can decline further toward its goal.
Inflation has fallen from its peak
Source: Bloomberg, monthly data as of 4/30/2024.
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 suggests it sees growth continuing at a moderate pace, but with higher unemployment. According to the Summary of Economic Projections, the unemployment rate is expected to rise to 4.2% next year, up from the 2024 year-end projection of 4.0%.
Economic projections of Federal Reserve board members and Federal Reserve bank presidents
Source: Federal Reserve Board, 6/12/2024.
For each period, the median is the middle projection when the projections are arranged from lowest to highest. When the number of projections is even, the median is the average of the two middle projections. The central tendency excludes the three highest and three lowest projections for each variable in each year. The range for a variable in a given year includes all participants' projections, from lowest to highest, for that variable in that year. Longer Run projections for core PCE are not collected.
Powell noted that wage growth is currently "unsustainable," suggesting that one criterion for rates would be a slowdown in this metric. We believe the Fed would be more confident on inflation if wage growth were closer to 3% than 4%.
U.S. average hourly earnings
Source: Bloomberg.
U.S. Average Hourly Earnings All Employees Total Private Yearly Percent Change SA (AHE YOY% Index). Data as of 5/31/2024.
Overall, the Fed's policy remains on hold, but the direction of interest rates is still expected to be lower. It may take longer than previously expected. 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.
The immediate reaction in the markets was a drop in bond prices. Treasury yields rose for all maturities after the meeting, but yields were still down for the day given the weaker-than-expected consumer price index report earlier in the day. 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 each in the federal funds rate in 2024.