(Reuters) - The Federal Reserve on Wednesday said it would leave interest rates unchanged and announced plans to slow the speed of its balance sheet drawdown, after having spent much of the earlier part of the year warning of this shift.
The Fed said that starting on June 1 it was reducing the cap on Treasury securities it allows to mature and not be replaced to $25 billion from its current cap of up to $60 billion per month. The Fed left the cap on how many mortgage-backed securities it will allow to roll off its books at $35 billion per month, and it will reinvest any excess MBS principal payments into Treasuries.
The announcements came at the end of its two-day Federal Open Market Committee meeting. It was widely expected to leave policy rate at 5.25%-5.50% but signaled it is still leaning towards eventual reductions in borrowing costs. It put a red flag on recent disappointing inflation readings and suggested a possible stall in the movement towards more balance in the economy.
Traders see November as the most likely timing for the first Fed rate cut, based on interest-rate futures prices, but also gave nearly even odds that the first rate cut will come in September. They gave about a 24% chance that the Fed won't cut rates at all this year, down from about 27% before the meeting.
In an afternoon press conference Fed chair Jerome Powell said it's unlikely that the central bank's next move would be a hike.
MARKET REACTION:
STOCKS: The S&P 500 reversed a slight loss to a 0.97% gain
BONDS: The yield on benchmark U.S. 10-year notes fell to 4.612%. The 2-year note yield fell to 4.948%
FOREX: The dollar index extended a loss to -0.46% with the euro up 0.5%
COMMENTS:
CAROL SCHLEIF, CHIEF INVESTMENT OFFICER, BMO FAMILY OFFICE, MINNEAPOLIS
“The depth of the balance sheet slowdown was bigger than expected, which should buoy spirits a bit in the fixed income markets. Clients and market participants are raising more and more concerns about the level of US debt and who is going to have the wherewithal to purchase all of it, so the Fed’s reduction in what it rolls is a plus.”
“The rest of the announcement was largely as expected given the three-in-a-row hotter CPI reports. Data out today and this week, though, is more indicative of a bumpy glide toward the Fed’s 2% target.”
JEFFREY ROACH, CHIEF ECONOMIST, LPL FINANCIAL, CHARLOTTE, NC
“It’s definitely a little hawkish on the surface. But the fact that the Fed is tapering a little bit more tells me they want to start easing conditions. They don’t want to add to the tightness. This shouldn’t be too much of a surprise to markets other than the taper changes. In essence there might be some downside pressure on rates in the near term as the short end of the curve falls a little bit. So at this point, we’re still beholden to future inflation reads.”
MONA MAHAJAN, SENIOR INVESTMENT STRATEGIST AT EDWARD JONES, NEW YORK
"Generally, coming into this our expectation was that Powell and the Fed would be a little more hawkish but some of that had been priced in already as markets are only expecting one rate cut this year now anyway."
"In recent weeks Powell and the Fed have leaned more hawkish given the upside surprises we've seen in inflation over the first three months of the year. Markets had adjusted accordingly.”
“The question that remains is whether they're on hold going forward or if they'd consider an alternative path of actually raising rates. That's not our base case and probably more a tail risk than anything."
"They're starting to slow the pace of tapering their balance sheet."
"The Fed had talked about it at the last meeting so there was an expectation it was coming in the back half of the year. It's probably somewhat on the early side. It's a signal that they're starting to think about easing policy and that's the first step in that direction. It could be taken as positive sign at least putting a little less pressure on Treasury markets.”
MICHAEL ROSEN, CHIEF INVESTMENT OFFICER, ANGELES INVESTMENT ADVISORS, SANTA MONICA, CA
“The decision to hold rates steady was no surprise, but the aggressive moderation in tapering, reducing the Fed’s balance sheet, was a bit of a surprise, and modestly bullish for bonds at the margin because it means that the Fed will allow less supply of bonds to hit the market off of its balance sheet.”
“But the Fed still has that sticky problem of inflation, which remains well above target and shows signs of moving higher. This means that any easing is still well into the future. Additionally, the complete lack of fiscal discipline means that the Treasury will have to float trillions of dollars of debt this year, a massive supply that will limit any bond gains.”
“With the Fed on hold and yield curve still inverted, we remain short duration, happy to earn the higher yields in the short end of the curve.”
JOHN VELIS, FX AND MACRO STRATEGIST, BNY MELLON, NEW YORK
“The lack of change in forward guidance (still implying the Fed sees the next move as a cut – dependent on inflation) was marginally dovish, and I am not sure the new inserted phrase about lack of progress on inflation is enough to offset that. I am surprised the Fed kept in the comment about potential future cuts.
"Balance sheet tapering is slightly faster than we expected ($25bn vs an expected $30bn), but in effect, since bonds had only been rolling off by an average of $51bn, the move to $25bn is effectively halving the actual runoff.”
MATT STUCKY, CHIEF PORTFOLIO MANAGER FOR EQUITIES, NORTHWESTERN MUTUAL WEALTH MANAGEMENT COMPANY, MILWAUKEE, WISCONSIN
"I don't think there's a whole lot of surprises in the statement. If there's any kind of slightly dovish tilt delivered versus expectations, it was that the cap on Treasury roll-offs was a little tighter than markets were anticipating.
"There's a reiteration in the statement that the Fed still views 2% as the inflation objective... if (inflation) doesn't live up to their expectations, they're not going to be cutting (rates) anytime soon."
SAM STOVALL, CHIEF INVESTMENT STRATEGIST, CFRA RESEARCH, NEW YORK
"They weren't really expecting any kind of shocking statement to come out of the statement. That thing is perused with a fine-tooth comb, and if there's going to be any kind of reaction up or down today, it'll be as a result of answers during the press conference.
“We are going to get employment data at the end of the week, so that's something. But there are several things that are going to hold back the market, in my opinion. One is the stickiness of the inflation, the actual inflation readings, the concern that we are seeing a slowdown in economic growth based on the recent GDP numbers, combined with PMI data, and consumer confidence coming in weaker than anticipated.”
BRIAN JACOBSEN, CHIEF ECONOMIST, ANNEX WEALTH MANAGEMENT, MENOMONEE FALLS, WISCONSIN“The Fed finally recognized that their balance sheet reduction was doing more harm than good. It wasn’t helping bring down inflation. It was just increasing bond market volatility. Financial stability concerns need to dominate their thinking. The Fed needs to use the right tool for the right job: rates for inflation and its balance sheet for financial stability.”
MICHELE RANERI, VICE PRESIDENT OF U.S. RESEARCH AND CONSULTING, TRANSUNION, CHICAGO (by email)
“The new GDP report is a likely indicator that the Fed’s previously announced ‘higher for longer’ interest rates are not going away any time soon. U.S. consumers should be prepared to continue to face relatively high interest rates across a range of credit products for a while longer, with any potential rate decreases likely being pushed to later in 2024.”
“Ultimately, this could result in the mortgage and auto markets remaining relatively sluggish as consumers continue to wait for rates to fall. Indeed, if interest rates do not begin to decline until later in 2024, this could mean that many home buyers may hold off until later 2024 or even into 2025.”
MATTHAIS SCHEIBER, GLOBAL HEAD OF PORTFOLIO MANAGEMENT, SYSTEMATIC EDGE TEAM, ALLSPRING GLOBAL INVESTMENTS, LONDON (emailed to Reuters)“As expected, the Federal Open Market Committee decided to keep its key interest rate, the federal funds rate, unchanged at 5.25–5.50%. We believe the Federal Reserve (Fed) won’t cut rates until it sees weakening in prices and labor market data—probably not before fall.“In addition to the fact that core goods’ deflationary impact on U.S. inflation is currently stalled, the positive base effects from 2023’s falling energy prices will wash out now. Service prices, which represent the largest driver of current inflation, have stabilized over the past three months after dropping meaningfully last year. The good news is that inflation’s breadth (how many goods and services are increasing at the same time) is coming down further. However, inflation’s persistence (how sticky inflation will be) has reaccelerated again. As a consequence, the short-term interest rate market has readjusted and is now more pessimistic on rate cuts: Compared with the Fed’s estimate of three rate cuts in 2024, the market—which originally anticipated five 2024 rate cuts—now expects just one.
“Our base case is for the Fed to hold until inflation and growth data weaken enough to justify less restrictive monetary policy. These conditions should be met by late in the third quarter of this year."
“We continue to favor bonds, which benefit from moderating growth and moderating inflation―particularly internationally. We also continue to like equities. Despite a short-term struggle, earnings and guidance have remained robust and any relief from perceived looser monetary policy would likely support equity prices in the medium term.”