For an off-cycle meeting of the Federal Reserve, this week’s meeting and the subsequent press conference were far more interesting than usual. I’d like to present three takeaways from the day’s events and share some thoughts on the Fed’s announcement regarding quantitative tightening (QT).
Much of the remarks made in the FOMC statement and by Chairman Powell confirm what we’ve seen previously – but maybe only on the surface. Some of the commentary suggests that the Fed is evolving its thinking based on the latest economic data and inflation prints, in particular, and the remarks that Powell made at the press conference put a new spin on a familiar set of facts.
1. A “signal” is more than a bump in the road – Both the FOMC statement and Powell’s remarks continued to stress that the lack of progress toward the 2% inflation goal has resulted in their wanting to see more data to help them determine when and if they will reach that goal. None of this is really new. However, unlike at the March meeting where Powell had characterized the two prior higher inflation prints as a “bump in the road,” this week he indicated that he has moved on from that line of thinking.
Powell essentially acknowledged that one or two higher prints is not the same as three in a row and that changes the picture. A quarter of data in Powell’s mind is a “signal” – and this is the twist. I think this is a big statement from Powell – a “signal” is more than a bump in the road – and we should bear it in mind as we look at future policy decisions on rates and how many data points the Fed wants to see to establish a “trend” in an economic indicator they are studying.
2. Rate increases appear to be off the table – Powell echoed comments made by a number of other Fed officials and reiterated a couple of times that they all believe that rates are sufficiently restrictive to slow the economy and bring inflation to 2%. He also once again stated that he didn’t think that inflation pressures were severe enough to raise rates, effectively taking a rate hike off the table in the foreseeable future. The markets, of course, loved this news, and reacted accordingly.
3. The labor markets are coming into better balance – The Fed also reiterated their belief that the labor markets are coming into better balance. (Again, this is not a new position). The most recent data, such as this week’s JOLTS data, ECI (employment cost index) report and even the employment report show that the labor market is cooling. Employees are quitting their jobs at a slower rate, the job openings data has declined and hiring rates have fallen. Payrolls, while not excessively weak, also seemed to have slowed to a more Fed friendly level. With this, Powell reaffirmed his conviction that wages will moderate somewhat as a result.
But here, too, Powell added a twist. For the past two years during the period of higher inflation, Powell has said that the Fed has been squarely focused on lowering inflation – not on boosting employment, the other part of its mandate. But this week he effectively said that the Fed has brought inflation down enough that it can now begin to focus on the employment side of its mandate.
Why is this important? Because it suggests that if the Fed once again has employment in its sights and the employment picture darkens, it may choose to ease. This, too, is a big change. Adding the jobs focus back into the Fed’s calculus on rate policy amounts to a shift and could skew the Fed to an eventual ease. This is the other reason the markets reacted so positively following the meeting.
A Brief Update on Quantitative Tightening
The Fed announced that they will be lowering the amount of treasuries that they are rolling off of their balance sheet from $60 billion per month to $25 billion per month. They also announced that they are leaving the amount of mortgages unchanged at $35 billion per month. They anticipate that the taper will begin in June.
This suggests that the Fed’s balance sheet will shrink less quickly, which implies that bank reserves will shrink at a slower pace. But perhaps even more significant is that it means that the QT process will continue for longer.
Our take is that this new pace of tapering combined with the RRP facilities current balances indicate that the Fed will probably continue QT through the remainder of the year, only ending when Bank Reserve balances fall to somewhere in the $2.7T-$3.0T range.
The Straight-Up Takeaway for Investors
The Fed has now quite cleverly created an environment where there are multiple paths forward for it to take on rates in the remainder of 2024 – anywhere from 3 eases to even a potential hike, depending on the near-term inflation prints and employment data. As a result – and despite the new twists – investors find themselves in a very familiar place: a period of continued high volatility for rates that we believe is going to endure for the rest of the year.