Market Views from the Global Fixed Income, Currency & Commodities (GFICC) group

In line with market expectations, the Federal Open Market Committee (FOMC) voted to keep the federal funds rate unchanged in a target range of 5.25% – 5.50%. There were no dissents.

Changes to the FOMC Statement:

  • The economic assessment was changed to acknowledge continued economic growth as well as the acceleration in inflation in recent months. Nevertheless, the risk to their dual mandate remains better balanced.
  • The forward guidance was unchanged: The Fed stated for a third meeting in a row that it “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%.”
  • The Fed also announced it would taper Quantitative Tightening (QT) at the beginning of June by reducing the monthly redemption cap for Treasuries from 60bln to 25bln and keeping the Agency MBS cap unchanged at 35bln.

3 Key Takeaways from Chair’s Press Conference:

  • On the policy rate:
    • Chair Powell believes that “the evidence shows pretty clearly that policy is restrictive and is weighing on demand.”
    • He thinks it’s “unlikely the next policy rate move will be a hike” and the focus is “how long to keep policy restrictive.” He believes that it’s clear “restrictive monetary policy needs more time to do its job, [and] how long that will take and how patient we should be depends on the totality of the data.
    • To restart the hiking cycle, he would need to see “persuasive evidence that our policy stance is not sufficiently restrictive to bring inflation down to 2%.”
  • On inflation, the Fed recognizes that in recent months “inflation has shown a lack of further progress toward our 2% objective.” While they wouldn’t react to 1-2 prints, the fact that was a full quarter of data was a signal, and “the signal [they’re] taking is it's likely to take longer for [them] to gain confidence that [they’re] on a sustainable path to 2% inflation.”
  • On QT, Chair Powell explained that the decision to taper caps “does not mean that our balance sheet will ultimately shrink by less than it would otherwise. But rather allows us to approach its ultimate level more gradually…to ensure a smooth transition [and] reducing the possibility that money markets experience stress.” He views this as separate from the active tool of monetary policy, which is interest rates.

Our View:

  • Since the Fed last hiked rates in July 2023, core PCE (the Fed’s preferred measure of inflation) has decelerated by 200bps to 2.8% YoY but remains elevated and the unemployment rate has risen slightly to 3.8% but remains low. These developments justify the Fed’s decision to end the hiking cycle as the risks to achieving the Fed’s dual mandate of stable 2% inflation and maximum employment are now more balanced. The Fed remains focused on how soon, how fast, and how far the easing of policy needs to go.
  • Given that we still believe the Fed is biased toward easing policy at some point later this year, Treasury yields should be skewed lower over time as investors look to lock in relatively high risk-free rates while they are still available. Nevertheless, markets will remain acutely sensitive to incoming economic data to the extent it confirms or refutes the Fed’s confidence that inflation is moving back toward target over time.
  • We expect the Fed to deliver its first rate cut this summer and the 10-year Treasury yields to move towards a range of 3.75 – 4.25% later this year as the Fed reduces policy restriction.