Understanding the Federal Reserve's Decision in One Article: Lack of Progress in Fighting Inflation, but Powell Says Rate Hikes Are Unlikely

Author: Sina Finance

In the early hours of Thursday Beijing time, Federal Reserve officials unanimously decided to keep the benchmark interest rate unchanged in the range of 5.25%-5.5%. The rate statement reiterated that more evidence of cooling inflation is needed before considering a rate cut. The Fed expressed new concerns about inflation, suggesting that it may maintain higher rates for a longer period, but will not raise rates again.

Powell stated at the press conference, "So far this year, the data has not given us more confidence in a rate cut; the inflation data is higher than expected, which means we may need to wait longer than anticipated to feel confident about a rate cut." Powell noted, "The next step for the Fed is unlikely to be a rate hike; a rate increase would require officials to see convincing evidence that monetary policy is not restrictive enough to bring inflation back to the central bank's 2% target. But we have not seen evidence supporting that conclusion."

These remarks reassured investors worried that the Fed might respond more aggressively to inflation. Both the U.S. stock and bond markets rose, with futures markets showing a slight increase in the likelihood of two rate cuts this year, rather than the one cut expected before the meeting. However, Powell did not hint at a possible rate cut this year, nor did he suggest that rates have peaked.

Federal Reserve Decision: Unanimously agreed to keep rates unchanged, reaffirmed waiting for greater confidence in inflation before cutting rates

① Inflation Outlook: Lack of further progress in achieving the 2% inflation target in recent months

The latest statement from the Federal Open Market Committee (FOMC) reiterated the consistent message since December that "inflation has slowed over the past year but remains elevated." However, it added a sentence: "There has been a lack of further progress in reducing inflation in recent months."

Another change is that the Fed stated that the risks to achieving the dual goals of employment and inflation "have become more balanced over the past year," using the past tense. Previous statements used the present tense, stating that risks "are becoming more balanced."

② Balance Sheet Reduction: Starting in June, the pace of Treasury bond reduction will slow to $25 billion/month, while the MBS reduction cap remains at $35 billion/month

Officials also outlined plans to slow the pace of balance sheet reduction, starting in June, by lowering the monthly cap on U.S. Treasury bonds that are not reinvested after maturity from $60 billion to $25 billion. The cap on mortgage-backed securities (MBS) remains unchanged at $35 billion, although the Fed will reinvest principal payments exceeding the cap into U.S. Treasuries instead of MBS.

On the balance sheet front, policymakers broadly agreed with the view from the March meeting that a cautious approach should be taken regarding further balance sheet reduction. Officials emphasized that the decision to slow the balance sheet reduction is unrelated to the timing of rate cuts.

③ Reaffirmed that job growth remains strong

Although price pressures rapidly eased in the last few months of 2023, progress toward the 2% inflation target stalled in 2024. Meanwhile, a strong labor market along with stable consumption and investment supports continued economic expansion. The rate statement reaffirmed that job growth remains strong, the unemployment rate is low, but economic growth is steady.

Key Points from Powell's Press Conference: It will take longer than expected to gain confidence in a rate cut; the next action is unlikely to be a rate hike

① Powell: The next action is unlikely to be a rate hike

Federal Reserve Chairman Powell stated that the next action is unlikely to be a rate hike. This follows the Fed's announcement to keep rates unchanged and suggests new concerns about inflation. "I do think it is clear that policy is restrictive," Powell said. "We believe that over time, its restrictiveness will reach a sufficiently high level."

② Powell: It will take longer to gain confidence in declining inflation

Federal Reserve Chairman Jerome Powell said that the decision-makers may need a longer time than previously expected to gain sufficient confidence in the inflation trajectory to initiate a rate cut. Powell stated at the press conference, "We have said that we do not think it would be appropriate to lower the federal funds rate target range until we have greater confidence that inflation is sustainably moving toward 2%." The U.S. central bank decided on Wednesday to keep the benchmark rate unchanged and hinted at new concerns about inflation. "The time required to raise this confidence may be longer than previously anticipated," Powell said.

③ Powell: Not very confident about a rate cut this year

Federal Reserve Chairman Powell stated that he is not very confident about whether there will be a rate cut this year and does not know if inflation will decline to a level sufficient for a rate cut. Given the current situation, he believes the Fed's policy stance is in a good position. Considering growth or inflation, he believes there is no stagflation issue. In 2023, there was a year of very high productivity growth, and potential economic output may see significant growth.

④ Powell: Committed to maintaining a restrictive policy stance at the appropriate time

Federal Reserve Chairman Powell stated that he is committed to maintaining a restrictive policy stance at the appropriate time; the next adjustment of the policy rate is unlikely to be a rate hike. The focus of policy is on how to maintain its restrictiveness. If a rate hike is to occur, evidence must be seen that policy is insufficient to bring inflation down to our target level. We are concerned about the duration of policy restrictiveness.

⑤ Powell: Slowing the pace of quantitative tightening does not mean the Fed's balance sheet will shrink more slowly than expected

Federal Reserve Chairman Powell stated that slowing the pace of quantitative tightening does not mean the Fed's balance sheet will shrink more slowly than expected; slowing the balance sheet reduction is not policy easing. The decision to slow the balance sheet reduction will reduce the likelihood of pressure in the money markets and ensure a smooth transition. The current slowdown in the balance sheet reduction is to ensure a smooth process, rather than causing market turmoil as in the last instance.

⑥ Powell: As inflation falls below 3%, the Fed's employment goal will again become a focus

Federal Reserve Chairman Powell stated that as inflation falls below 3%, the Fed's employment goal will again become a focus.

⑦ Powell: Unexpected weakness in the labor market could justify a rate cut

Federal Reserve Chairman Powell stated that the timing of a rate cut will depend on the data. Unexpected weakness in the labor market could be a reason for a rate cut.

⑧ Powell: The long-term impact of immigration on inflation should be neutral

Federal Reserve Chairman Powell stated that due to immigration, the potential output of the U.S. economy has seen "significant increases"; potential economic output may see significant growth. Immigration should have a neutral impact on inflation in the long term; initially, immigration may create more supply rather than demand in the economy.

⑨ Powell: Housing inflation will slow as long as market rents remain low

Federal Reserve Chairman Powell stated that market rents have hardly increased now. It takes years for market rents to fully reflect in renewal rents. I believe that as long as market rents remain low, this will be reflected in inflation.

⑩ Powell responds to the U.S. election: Elections are not part of our considerations

Federal Reserve Chairman Powell stated that the Fed will always act at the right time without considering other factors. Elections are not a factor of concern for the Fed.

Market Performance: Powell douses rate hike possibilities; U.S. stock market and U.S. Treasuries rise

The U.S. stock market expanded its gains after the Fed's decision was announced, with the Nasdaq 100 index rising by 1% to reach an intraday high, but subsequent gains narrowed, and the Nasdaq 100 index erased a 1.3% gain that occurred after the FOMC meeting statement.

After the Fed announced that it would keep rates unchanged and Powell answered questions, investors flocked to the U.S. stock market and U.S. Treasuries, pushing yields lower. Powell insisted that the data has not convinced policymakers that inflation is declining to the Fed's 2% target, making a rate cut unlikely at this time. He also did not hint at the possibility of a rate hike. During his speech, major U.S. stock indices rose by more than 1%.

U.S. Treasuries rose, with the increase mainly occurring during Powell's press conference after the Fed announced that it would keep rates unchanged. Powell doused the possibility of a rate hike, stating that the next adjustment of the policy rate is unlikely to be a rate hike, which allowed the bond market to avoid the previously feared hawkish shift. It seems that short covering somewhat boosted Treasuries, leading to an expansion of the day's gains before the close.

Shortly after 3 PM New York time, the yield curve fell by as much as 9 basis points from the short end to the middle, with the 2-year yield around 4.95%, dipping to 4.923% at one point. The steepening of the yield curve was largely maintained, with the 5s30s yield spread widening by about 3 basis points on the day.

OIS contracts linked to the Fed meeting turned more dovish, returning to levels similar to those before the release of the employment cost index on Tuesday; the market implied a rate cut of about 33 basis points by December, compared to 26 basis points at Tuesday's close.