Most people think that the Federal Reserve will keep its key interest rate the same when their two-day meeting ends on Wednesday. However, economists will be keeping a close eye out for any hints about when the first rate cut in four years might happen.
The Federal Reserve has told people to be patient because the drop in inflation has not sped up in the first three months of the year. This means that there will be no move next week. Ian Pollick, head of fixed income strategy at CIBC Capital Markets, said this.
Most economists agree that the good May jobs report that came out on Friday made it look like there would be no rate cuts at the July meeting.
Pollick said that Fed Chairman Jerome Powell is likely to say again that the Fed is still not sure that inflation is moving back to goal.
Since July of last year, the Fed has kept its main interest rates at 5.25 percent to 5.50 percent. Powell is likely to stick to his message that this rate is lowering inflation enough to slow demand, but that it needs to be kept “tighter for longer” to really cool inflation.
That means the first rate cut might not happen until 2025, at one of the last three FOMC meetings of the year, in September, November, or December.
According to experts, the central bank’s policy statement and the new economic forecasts that come out at 2 p.m. Eastern on Wednesday will give them hints. A half-hour later, Federal Reserve Chair Jerome Powell will hold a press conference.
Adding to the confusion, the government will report the rise in consumer prices for May the morning of the Fed’s decision. A study by the Wall Street Journal asked economists if they thought inflation would go down. This might change how the Fed thinks about things.
The following questions will be very important to economics next week.
Will officials pencil in one or two rate cuts for this year?
In March, Fed officials thought that three rate cuts were likely to be the best policy choice for 2024. With inflation so stick, most economists think the Fed will only project one or two cuts.
If the Fed pencils in two cuts, that will be seen as dovish, Pollick of CIBC said. That will be an indication that a rate cut is possible in September, before the presidential election. Many economists see the Fed forecasting two cuts. It would give them flexibility.
One rate cut would be more neutral, Pollick said.
The Fed is likely to see three cuts in 2025 and 2026 even though there is more talk that the “neutral” level of the Fed’s benchmark rate has moved higher.
How many Fed officials will pencil in zero rate cuts this year?
Based on public comments, some Fed officials might move their “dot” to signal no rate cuts this year.
If a significant number do, that would challenge the general sense of economists that the Fed is still leaning toward cutting interest rates this year.
Yelena Shulyatyeva, economist at BNP Paribas, sees three Fed officials will be in the no-cut camp. She sees six officials in the one-cut camp and ten officials penciling in two cuts.
Ryan Sweet, chief U.S. economists at Oxford Economics, also downplayed the chances of a significant number of officials penciling in zero cuts.
“I don’t think they will move the needle that much,” he said, in an interview.
Will there be any changes to the Fed’s overall narrative about inflation?
Powell has been perceived as dovish at his post-meeting press conferences and that is expected to continue, said Michael Feroli, chief U.S. economist at JP Morgan Chase. A forecast of two cuts would allow Powell to continue to say that inflation is coming down.
The Fed is grappling with two surprises on the inflation front, said former Fed Governor Larry Meyer. First there was a sharp disinflation last year and this was followed by a sharp rebound in inflation in the first few months of this year.
The big question is where will the economy be when this rollercoaster rise is over.
“It will take several months of improved inflation data before we have a better reading on where we are and what the trend is,” Meyer said.
Could Powell guide investors to how to read inflation data?
In his last remarks before Fed officials stopped giving speeches last week ahead of Wednesday’s meeting, Powell said he expects inflation will move back down on a monthly basis to the lower readings seen in the second half of last year.
That’s a notable shift in messaging, according to Ellen Zentner, chief U.S. economist at Morgan Stanley. Fed officials most often speak about inflation on a 12-month rate. Even their inflation target is set out as a 2% annual rate.
Economists know that the annual rate of inflation won’t make much progress this year. That’s because the monthly readings will have to compare with the low inflation readings of the second half of last year. So the annual rate won’t come down much even if the monthly data improve.
Zentner said Powell is signaling that the Fed will be looking at “sequential” improvement.
Meyer put it this way. “The Fed will want to see that the six-month inflation is rate is below the 12-month rate and the three-month rate is below the six-month rate,” he said, in a note.
If the data come in this way, the Fed will be able to cut rates starting in September, Zentner said. This will be followed by cuts at every meeting through mid-2025, she said.
“Lost in the narrative was Chair Powell’s comments, before the blackout, that it is the sequential pace of monthly inflation that matters most in terms of gaining confidence they need to start cutting rates,” Zentner said.
“I fully expect him to repeat that at next week’s Fed meeting, in the Q&A,” she added.
Will there be any talk that the next move would be a rate hike?
Minutes of the Fed’s last meeting in early May show that officials were prepared to hike rates again “should risks to inflation materialize in a way that such an action became appropriate.”
But economists said they don’t expect that the chances of a tightening have increased in any meaningful way.
“We don’t think any dots will show hikes, but if that’s wrong it will complicate Powell’s message,” said Michael Feroli, chief U.S. economist at JP Morgan Chase.
“Powell will likely keep a high bar for rate hikes in place, it is a low probability event,” said Michael Gapen, head of U.S. economics at BofA Securities.
Thomas Hoenig, the former president of the Kansas City Fed, said in an recent interview that a rate hike would be too risky and would rock markets.
“I don’t know very many people on the FOMC who want to raise rates,” Hoenig told top Fed watcher Kathleen Hays in her substack interview.
So long as inflation doesn’t rise, the Fed will wait and see, he added.
