Fed Did Not Change Rates As Expected

Fed Did Not Change - Doesn't Hike Rates

In a surprise to almost nobody, the Fed didn’t hike or cut rates at its meeting on May 1st. My opinion was in line with expectations for this meeting. However, I don’t see the Fed cutting rates this year and the market does. As a result of the Fed decision and statement, the Fed funds futures market now shows there is a 52.9% chance of a cut this year. 

The futures market isn’t that far away from my opinion. Just prior to this meeting, on April 30th, the odds of a cut were 66%. In that sense, you can say the meeting was slightly hawkish.

June meeting has a 6.7% chance of a cut which is a major swing from the 22.4% chance of a cut the day before the meeting. The closer the meeting, the more the odds matter. The futures market is usually wrong about the intermediate term future. 

However, the Fed rarely goes against what the futures market expects on decision day. If the Fed actually thinks it will cut rates in June, it will soon come out and change forward guidance. That is very unlikely to happen. There won’t be enough data in 6 weeks to completely change course. If the data weakens, the Fed will be more likely to cut by the end of the year.

Fed Did Not Change - Lowers IOER 5 Bps & Goes Through With QT

The Fed lowered the interest rate on excess reserves to 2.35% from 2.4%. It is now 15 basis points below the top end of the Fed’s target range. Fed stated the goal with this small change is to foster trading in the Fed funds market at rates within the FOMC’s target range. A goal of this change in the IOER is to get the Fed funds rate under control.

Fed funds rate has been creeping higher even though the Fed hasn’t hiked rates. Specifically, the Fed funds rate is at 2.45% which is just 5 basis points below the upper bound. It would be a big deal if the Fed funds rate went above the FOMC’s target. 

Investors would lose confidence in the Fed. The Fed is directing the Open Market Desk to go through with open market operations to keep the Fed funds rate within the range of 2.25% to 2.5%. This action includes overnight repurchase operations at a rate of 2.25%

The Fed is also going through with its QT program which will end later this year. Treasury holdings will decline by $15 billion per month and mortgage-backed security holdings will decline by $20 billion per month. There’s no news here.

Fed Did Not Change - Specific Changes To The Fed Statement

Fed’s statement only had changes to the first paragraph. That’s why the image below is shorter than usual. As you can see, the Fed stated “the labor market remains strong and that economic activity rose at a solid rate.” 

That’s different from March’s statement which said, “the labor market remains strong but that growth of economic activity has slowed from its solid rate in the fourth quarter.”

It’s interesting to see the Fed claim the economy is solid after that weak Q1 GDP report. Maybe the Fed is looking at the March durable goods orders report. The labor market is obviously strong as job creation was strong in March. We’ll see how strong the labor market was in April on Friday. 

As you know, anytime the Fed is more positive on economic growth, it’s a hawkish statement. This explains why the Fed funds futures market lowered the chances of at least one cut in June and the chances of a cut by the end of the year.

(Click on image to enlarge)

Their second statement change was about the labor market. March statement said, “Payroll employment was little changed in February, but job gains have been solid.” This new statement just says, “job gains have been solid.” 

Basically, the assessment of the labor market is that it is still strong. The only change was the Fed not mentioning the recent blip lower because the weak February reading is long gone. This doesn’t imply anything about future monetary policy.

The third change to the statement finally recognizes the weak underlying numbers in the Q1 GDP report. However, it looks like a re-wording of the same point. It went from “recent indicators point to slower growth” to “growth…slowed.” It seems like the “indicators” the Fed used were correct. It’s a slight increase in confidence that the economy was weak in Q1. That’s modestly dovish.

Fed Did Not Change - Is Low Inflation Here To Stay?

A final change was on inflation. Fed went from stating, “overall inflation has declined largely as a result of energy prices; inflation for items other than food and energy remains near 2%” to “overall inflation and inflation for items other than food and energy have declined and are running below 2%.” 

With that change, the Fed acknowledged the recent decline in inflation. 

One of the most notable parts of chairman Powell’s press conference was when he stated, “We suspect transitory factors may be at work” when referring to the drop in inflation. He mentioned that inflation should return to the Fed’s target over time, and then be symmetric around its objective. 

Finally, he stated, “If we did see inflation running persistently below, that is something the committee would be concerned about and something we would take into account when setting policy.”

It’s fair to suggest low inflation is temporary because the economy is in a slowdown. Once that ends sometime later this year, I expect inflation to rebound. It’s interesting that he would be concerned about low inflation because the best case scenario is high growth and low inflation. His philosophy is based on the concept that growth and inflation are joined at the hip, meaning low inflation is bad because it means low growth.