If we compare Federal Reserve Chairman Powell and his colleagues to parents traveling long distances with their children, perhaps it is most appropriate:
Investors eager to cut interest rates keep asking policymakers, "Have we reached our destination?"
So far, they have repeatedly replied, "It's fast, but it hasn't arrived yet..."
As the Federal Reserve officially enters a period of silence before its January resolution starting from last weekend, it is widely expected that the Federal Open Market Committee will hold its fourth consecutive meeting to maintain interest rates unchanged at its first year-end monetary policy meeting from January 30th to 31st. However, the real focus of the market has now shifted to a more distant future - the direction of interest rates at the Federal Reserve's March and subsequent meetings.
Federal Reserve policymakers have recently stated that they are ready to start discussing the broad parameters that will affect interest rate cuts, and at their last meeting in December, they only nodded hastily on this topic. Some decision-makers have also expressed their willingness to consider lowering interest rates in the first half of 2024 if inflation declines faster than expected.
However, officials have not given any indication yet that they plan to use the upcoming January meeting to preheat the March interest rate cut - although it is not entirely ruled out at the moment that they may cut rates based on economic changes from now to then.
San Francisco Fed Chairman Mary Daly said last Friday that the idea of a rate cut is still "too early". She pointed out that before relaxing policies, she needs to see more evidence that the inflation rate is continuing to return to the 2% track.
The Federal Reserve has no sense of urgency to cut interest rates
For Federal Reserve officials, the current situation is actually quite favorable for them. Morgan Stanley Chief US Economist Ellen Zentner stated that the Federal Reserve can now be patient and wait.
From the current economic and market context, Powell and his colleagues can indeed take it slow - because there is currently no sign that they need to respond to economic contraction through significant interest rate cuts, as has often happened in the past. On the contrary, they can gradually adjust their policies to adapt to the sustained decline in inflation rates from decades high points set a year and a half ago.
Federal Reserve Director Waller also pointed out in a speech at the Brookings Institution on January 16th, "With good economic activity and labor market conditions, inflation rates are gradually falling to 2%, and I don't think there is a reason to take action or cut interest rates as quickly as in the past."
His remarks, combined with stronger than expected retail sales in December, prompted investors to significantly lower their expectations for a rate cut in March last week.
According to the latest pricing of the Federal Reserve observation tool by the ChiNext, traders in the interest rate futures market now expect a slightly lower probability of a rate cut in March than 50%. In other words, the exact estimate of the first interest rate cut has been postponed until May. Just a week ago, people once believed that the probability of a rate cut in March was as high as about three-quarters.
Federal Reserve officials are still trying to avoid the "worst-case scenario"
In fact, history has also proven that the Federal Reserve should remain cautious when initiating interest rate cuts. In the 1970s, the Federal Reserve relaxed its policies prematurely before inflation truly subsided. Even Paul Volcker, hailed as one of the greatest chairmen in the history of the Federal Reserve, made such a mistake during economic weakness in 1980, but later had to go the other way, plunging the United States into a deeper recession.
Atlanta Fed Chairman Bostek told business leaders last Thursday (January 18) that the worst outcome now is that Fed policymakers have lowered interest rates, but inflation has since risen, forcing them to raise interest rates again. He pointed out, "We don't want this kind of top-down or repetitive pattern to occur."
Former Federal Reserve staff member and economist Claudia Sahm believes that this idea may indeed prompt the Fed to postpone its first interest rate cut until May. She said that once the central bank starts taking action, it may happen soon.
She pointed out, "If inflation looks really good, they may cut interest rates by 50 basis points in the second half of the year."
Focus before January resolution
Federal Reserve policymakers will receive the latest performance from their favorite inflation indicator, the Core PCE Price Index, this Friday. On Thursday, the initial GDP data for the fourth quarter of the United States will also be released.
Industry insiders predict that the fourth quarter GDP data in the United States may indicate a slowdown in economic growth, expected to be around 2%, and the full year GDP will be around 2.7%, making inflationary pressures less apparent. The annual rate of the core PCE price index in the United States in December is expected to further decline to 3%, lower than the previous value of 3.2%.
The Federal Reserve's interest rate chart for December shows that officials expect to cut rates by 75 basis points in 2024. Bostic said in an interview last Friday that he is willing to change his view on the timing of interest rate cuts based on data, but he also hopes to ensure that inflation "smoothly" reaches the central bank's target of 2% before easing policies.
At the upcoming January meeting, a decision that FOMC must make is whether to change the forward-looking guidance for future policy actions in the post meeting statement. After a cumulative interest rate hike of 525 basis points since March 2022, Federal Reserve policymakers at last December's meeting still slightly opened the door to the possibility of further rate hikes.
It is still unclear whether retaining the door to interest rate hikes is still applicable. Many officials believe that the risk of re accelerating inflation - the possibility of further interest rate hikes - has decreased. But as the bond and stock markets rebound due to hopes of interest rate cuts, hawkish members of FOMC may not be willing to easily abandon this guidance.
Dallas Fed Chairman Logan told economists on January 6th, "Given the loose financial environment in recent months, we should not rule out the possibility of further interest rate hikes."
Concerns about the election year
It is worth mentioning that a major background for the Federal Reserve's current policy shift is being in an election year, which may also add some concerns when formulating policies.
Morgan Stanley economists Matthew Hornbach and Seth Carpenter pointed out in a report on January 17th not to assume that the upcoming US election will affect monetary policy.
But this does not mean that the Federal Reserve can escape criticism in this year's election campaign, especially if the main Republican candidate Trump is concerned that the Fed's interest rate cut will help Biden, it is inevitable that there will be some complaints or accusations.
Diane Swonk, Chief Economist at KPMG, said, "No matter what decision the Federal Reserve makes, it may be criticized for influencing the election."