Jerome Powell’s No Cut Thunderbolt
Groucho Marx famously said he would not join any club that would have him. What happens, however, when the club joins you?
We have been arguing since early December that economic growth was too strong to justify an interest rate cut in the first quarter of this year. Unemployment remained ultralow and consumer spending strong. The disinflationary forces of the first half of 2023 appeared to be losing steam in the second half, making ongoing progress on bringing inflation back to the two percent target far from a sure thing.
For a long time, this was a lonely place to stand watch while the market priced in a near certainty of a cut at the March meeting. Even as the incoming data showed the economy was not faltering and inflation was actually ticking up a bit, the “club” of Wall Street persisted in the view that the Fed would cut.
On the morning of the Federal Open Market Committee‘s January announcement, market prices implied a 60 percent chance of a March cut. In our view, this was evidence of narrative conviction triumphing over data observation.
Our expectation was that Fed chairman Jerome Powell would likely send a message to the market during his press conference that the Fed was in no rush to cut rates. With no impending recession or even serious weakness in the labor market, the mandate to re-establish price stability would dominate. And that would mean the Fed would need longer to be certain inflation had weakened enough that lower rates would not re-ignite it.
The thunderbolt thrown down from Marriner S. Eccles Federal Reserve Board Building on Wednesday, however, was even louder than we expected. Instead of waiting to rumble out the news in the press conference, the Fed broke the skies open in the FOMC’s official statement.
In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.
This should have been a clear enough message. The Fed did not just say it did not think it was appropriate to cut rates now. It said it did not “expect it will be appropriate” in the future. The use of the future tense implied that a cut in March was being taken off the table.
There is always a half-hour between the release of the Fed statement at two o’clock and the start of the Fed’s meeting. During this interval, traders often push asset prices around while they try to anticipate how the Fed chair will explain the statement.
On Wednesday, a number of prominent analysts felt confident that the March cut narrative was still plausible and the chances of a March rate cut were still alive. It would be uncharitable to name any names but it would probably have been a good idea for some of them to stay off the television shows and off social media for a little while.
Even as Powell began his press conference, he seemed to think the message was clear. But as the conversation with reporters went on, it became increasingly clear that people were still so attached to the idea that the Fed might cut in March that something more needed to be said.
So Powell said it.
Fascinatingly, there are still some clinging to the idea that the Fed could cut rates in March. We think of them as Zombie March Cutters (ZMCs) who continue on as the undead and probably will until the Fed actually does not cut rates in March. The fed fund futures market unbelievably still implied a 38 percent chance of a March cut.
Still, the consensus among analysts now is that the Fed will not cut in March. So we find ourselves in the awkward position of suddenly being among the consensus. It feels a bit icky and awkward. We’re not sure we like the club and we’re not about to hang a portrait of Chairman Powell on our wall.
Fortunately, we’re still out of consensus when it comes to what happens after March.
A Narrow Window For Fed Cuts
The question for Fed watchers has now moved on to when the Fed will cut rates.
But they should also be contemplating the possibility that the Fed will not cut at all this year.
There’s a strong caucus for a May cut. “The Fed kept its target rate at 5.25% to 5.5%, and might not cut it until May,” the Wall Street Journal‘s Greg Ip wrote Wednesday. The futures market is implying a 95 percent chance of a May cut.
That strikes us as unlikely. There’s just one inflation report and one jobs report between the meeting ending on March 20 and the meeting ending on May 1. At the May meeting, the Fed will have inflation and reports for January, February, and March but not April. If they know now that they will not be ready to cut in March, it would be odd for that readiness to develop just six weeks later.
A June cut is more plausible. The Fed may, however, decide to wait for July, which would be the one year anniversary of its last hike. Officials could rest assured that they had nearly a full year’s data about how the economy reacted to the pause in rate hikes.
If the Fed wants a full year’s data, it would have to wait until the September meeting. The trouble is that the country will be on the precipice of the presidential election in September. A cut at that point would open the Fed up to accusations that it was engaging in election interference or political manipulation of rates.
At that point, it would likely choose the safer course of holding off until after election day. Here the calendar works in the Fed’s favor because election day is on November 5th and the FOMC meeting is scheduled for the 6th and 7th (a day later than the usual Tuesday-Wednesday schedule). A cut on the day after election day would be less politically explosive than a cut eight weeks before.
There’s a non-trivial chance that the Fed does not get to cut rates at all this year. As we have been warning, there are plenty of reasons to worry that inflation will accelerate. If it does, that could take Fed cuts off the table for the rest of the year.
With this idea that there could be no cuts this year, we once again find ourselves alone in the wilderness. But that’s how we like it.