Today market the final FOMC meeting of the year. As outlined in my recent portfolio update, the Federal Reserve, as widely anticipated, opted to maintain interest rates at the current range of 5.25-5.50%. In addition to this decision, the Fed made some dovish adjustments to its statement.
Following the release, equities immediately experienced a rapid surge, maintaining the upward momentum throughout the entirety of the press conference. Simultaneously, the dollar depreciated significantly as the interest rate differentials with other currencies narrowed. Nevertheless, considering tomorrow’s impending rate decisions from both the BoE and the ECB, prudence suggests waiting for the outcomes of these decisions before putting on any trades.
In any case, what proved surprising for many market participants, myself included, was the indication of a more substantial revision to its rate projections than expected. Specifically, the median rate for 2024 was revised downward from the previous 5.1% to 4.6%, below the consensus expectation of 4.9%: this implies the prospect of three full cuts next year from the present levels. Likewise, the median dot for 2025 dropped from 3.9% to 3.6%, while the projections for 2026 and beyond remained unchanged at 2.9% and 2.5%, respectively.
However, I’m inclined to believe that the actual cuts next year could exceed the projections outlined in the dot plot, driven more by political considerations than purely economic factors.
The downward revision of the projected rates was not driven by political considerations, although this will be a crucial consideration in the coming year. Instead, it stems from a more optimistic economic outlook, indicating a faster-than-expected progress in mitigating inflation, without significant sacrifices in terms of growth. The tabulated data below illustrates this idea very well, with Core PCE projections decreasing from 3.7% to 3.2% in 2023, 2.6% to 2.4% in 2024, and 2.3% to 2.2% in 2025.
It is noteworthy that unemployment rate projections remain unchanged until 2025, a position I personally perceive as somewhat overly optimistic. Conversely, the GDP forecast for 2024 has been marginally revised downward to 1.4% from the prior 1.5%.
If you wish to read the entire document, you find it here.
Shifting focus, the statement witnessed a subtle tempering of its tightening guidance. Specifically, it introduced the term “any” in the phrase “in determining the extent of any additional policy firming that may be appropriate…”, marking a notable addition. Furthermore, it retained the language introduced back in November, characterizing financial and credit conditions as tighter, despite some expectations for its removal following the subsequent rally observed in U.S. Treasuries and stocks.
Additionally, the statement acknowledged a deceleration in growth from the robust pace experienced in Q3. It also acknowledged that inflation has moderated over the past year but retained the language emphasizing its persistent elevation.
In summary, we can call it a dovish hold. Indeed, Powell himself explicitly indicated that the Fed believes it is either at or near the peak of the current hiking cycle when questioned about future rate increases. While the possibility of further hikes certainly remains on the table, the likelihood appears minimal. Furthermore, despite market attempts to anticipate the central bank’s moves this year, Powell reiterated that the Fed prioritizes its internal forecasts and models, remaining unconcerned about market sentiments.
Nevertheless, a crucial point emerged during the discussion: Powell emphasized that the Fed might opt for rate cuts even in the absence of a recession. Despite numerous attempts to extract specific criteria guiding the Fed’s decision on timing and reasons for potential cuts, Powell remained evasive, emphasizing that the Fed will base its decisions on comprehensive aggregate-level data.
As previously mentioned in my tweet, if inflation decreases to a point where the previously justified monetary policy is no longer warranted, rate cuts would be considered. According to Powell, this is the scenario the Fed is hoping for. The primary difference between rate cuts in response to declining inflation and cuts prompted by economic weakness lies in the ability to sustain balance sheet normalization in the former scenario. Nevertheless, a concern arises regarding the potential aftermath of a rate cut – the risk that inflation could surge once again, potentially causing the central bank to “lose a tempo” and compromise its credibility.
Anyway, it is premature to delve into such discussions. The market is currently split, with some anticipating cuts in Q1 and others, including myself, foreseeing them in late Q2.