In brief

• The Federal Open Market Committee (FOMC) left the federal funds target range unchanged at 5.25%-5.50%, as anticipated. However, the quarterly update for the Summary of Economic Projections (SEP) suggested a dovish bias, with the “dots” pointing towards three cuts for next year, with a rate at the end of 2024 of 4.50%-4.75%. The market reacted by increasing expectations for rate cuts in 2024, pricing in cuts more aggressively than the Federal Reserve (the Fed). 


• The Fed maintained its quantitative tightening (QT) operation, with no immediate impact on market liquidity. The reverse repurchase (RRP) operation remains an outlet for Fed balance sheet adjustments and has helped absorb higher Treasury General Account (TGA) balances driven by increased Treasury bill issuance and a shrinking Fed balance sheet from QT.
  


• As we are likely at peak policy rates, money market funds continue to look for opportunities to extend out the curve, adding fixed rate duration to lock in yields as the Fed prepares for cuts.

December FOMC highlights

The FOMC unanimously decided to make no changes to the 5.25%-5.50% federal funds target range. Interest on reserve balances (IORB) and the overnight reverse repurchase (RRP) rate were also left unchanged at 5.40% and 5.30%, respectively. The decision to leave rates untouched was largely anticipated by the market, which ultimately left the SEP and Chairman Jay Powell’s comments as the focal points of the discussion.

The SEP, which is released quarterly on FOMC meeting dates, contains the most likely outcomes for growth, unemployment and inflation over the next few years and the longer run, as projected by each FOMC participant. In addition, the Fed released its “dot plot” at the same meeting, which shows current estimates for the Fed’s monetary policy path.

The December SEP forecasts suggested a soft landing in 2024, with disinflation continuing and unemployment increasing only slightly from current levels. The FOMC revised growth forecasts slightly lower and inflation forecasts substantially lower compared to the September release, indicating the Fed’s confidence that inflation is on a path back to its 2% target. The economy remains resilient despite 500 basis points (bps) of policy adjustments since March 2022. In the September SEP, the median dot for year-end 2023 pointed towards one additional hike this year. Since the Fed has remained on pause, the forecasted hike has been unrealised and the median expectations for the federal funds rate in 2024 and 2025 were revised 50bps and 25bps lower to 4.625% and 3.625% respectively. Despite lower expectations for the federal funds rate, real interest rates remain restrictive.

EXHIBIT 1: IMPLIED FED FUNDS FUTURES

Forecasts are not a reliable indicator of future results.

Source: J.P. Morgan Asset Management and Bloomberg, as of December 13 2023.

EXHIBIT 2: FOMC DECEMBER 2023 ECONOMIC PROJECTIONS

Forecasts of FOMC participants, median estimate. Longer-run projections for core PCE inflation are not collected. Forecasts are not a reliable indicator of future results.

Source: FOMC, as of December 13 2023.

The FOMC altered its policy statement to reflect a dovish pivot saying it will consider “any additional policy firming”. The addition of the word “any” along with Chairman Powell’s response to a question that rate cuts were “a discussion for us at our meeting today” was the confirmation the market was looking for that the Fed is done hiking. Powell expects the Fed to cut rates prior to inflation reaching 2%, otherwise as inflation continues to decrease, real rates will become increasingly more restrictive. Powell reflected the tone of the SEP while acknowledging the progress that has been made on bringing these estimates in the direction of long-run expectations.

Market expectations for future policy rates continue to adjust. The market reacted by increasing expectations for 2024 from four rate cuts before the statement to over five cuts by the time Chairman Powell finished his press conference, and six cuts by the next morning. Ultimately, the Fed will continue to proceed meeting by meeting based on the totality of incoming data and the balance of risks.

The Fed made no changes to its quantitative tightening (QT) operation, which continues to run in the background with no immediate impact to market liquidity. The Fed’s reverse repurchase (RRP) operation, currently about $800 billion, remains an outlet for Fed balance sheet adjustments. The RRP is considered a liability on the Fed’s balance sheet. As it declines, it can offset an increase in another liability, such as the increase seen in the Treasury General Account (TGA) since the debt limit resolution. The TGA has reached its stated goal of about $750 billion. A decrease in the asset side can also absorb decreases in the RRP. Quantitative tightening, which decreases the Fed’s assets, can offset the RRP. However, decreases in the RRP that exceed the pace of QT will increase bank reserves, which we have seen rise to $3.5 trillion. We do not expect to see reserve tightness until RRP decreases to or near zero. Currently, the RRP operation is serving its purpose as a release valve to the storage tank that is excess liquidity.

Implications for investors

Global Liquidity’s suite of USD money market strategies continues to benefit from elevated rates at cycle highs. As we believe we are at peak policy rates, USD money market strategies will continue to look for opportunities to add fixed rate duration and extend Weighted Average Maturities (WAMs). Even with rate cuts forecasted in 2024, money market fund yields typically lag any decline in market rates, which should keep the sector in focus as an asset class for some time.

Unless otherwise stated, all data is soured from J.P. Morgan Asset Management, as of December 13 2023.

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