Connecting the Dots on Fed Policy

Below is a transcript of this week’s video.

Hi, this is Mike Reynolds with Investment Strategy at Glenmede.

Patience is a virtue and apparently the preferred tactic for the Fed right now. The Federal Open Market Committee opted to keep rates unchanged last week for the fifth meeting in a row. This was well expected by markets ahead of time, especially since inflation has shown some signs of reaccelerating to start 2024. For example, the three-month annualized growth of the core consumer price index, which removes the impact of the more volatile food and energy components, now sits at 4.2%, which is the same place it was in the middle of 2023. This is the main factor holding the Fed back from normalizing rates.

Investors also got an updated dot plot last week, which showed Fed officials’ expectations for short-term rates by year-end. Each dot represents the opinion of one of the members on where they see fed funds ending up by the end of this year. Overall, the dot plot was relatively unchanged, as the median respondent still favored three rate cuts in 2024. However, only one voter placed their dot at levels implying more than three rate cuts this year, down notably from five voters in the December release. This means that the Fed really seems to be coalescing around three rate cuts for 2024.

Another feature of last week’s release is an updated Summary of Economic Projections that the FOMC publishes. The median respondent upgraded real GDP growth expectations pretty materially since the last time it was published in December, up to 2.1% from 1.4% for 2024. However, that stronger growth prescription could come with side effects. They also revised higher their core inflation projections, up to 2.6% from 2.4%, expressing the view that inflation could remain stickier amid a healthier growth backdrop.

The market reaction last week was relatively supportive, given that it aligned decently well with investor expectations. Markets have been coming around to the idea that a modest amount of rate cuts are in the cards for 2024. For example, fed funds futures were pricing in six rate cuts as the most likely outcome at the turn of the year, but those expectations have been revised pretty materially down to three, in-line with the Fed’s dot plot projections.

So what does this all mean for investors? Going forward, investors should pencil in three rate cuts for 2024 beginning sometime around summer, but they’ll need to make sure that pencil has a decent eraser, as inflation could keep the Fed higher for longer if it remains sticky. Higher for longer means cash and bonds may continue to clip pretty healthy yields for longer before adjusting lower alongside eventual Fed rate cuts. 

So to summarize, the Fed kept rates unchanged last week, which was widely expected given some hotter inflation prints to start the year. The dot plot showed little change, with only one member predicting more than three rate cuts this year. The Fed’s latest economic projections foresee stronger growth, but there are some lingering concerns about persistent inflation and market expectations have shifted in line with this thought process. For investors, they should be prepared for three rate cuts in 2024 but should keep their expectations flexible due to inflation uncertainty. As a result, cash and bond yields are expected to remain elevated for longer, though they may come under pressure once the Fed starts to deliver on rate cuts.

Thanks for listening! And please don’t hesitate to reach out with any questions.