Fed minutes give no indication of rate cut timeline

4 Jan 2024 , 01:52 PM

Fed gives little indication about its dovish game plan

When Jerome Powell made his statement on December 13, 2023, it did look like a sharp divergence from his usually hawkish undertone. In his post Fed meet conference on December 13, Powell clearly indicated that there would be at least 3 rate cuts in 2024 and 4 rate cuts in 2025. That would cumulate to around 175 bps of rate cuts over the next 2 years. The CME Fedwatch was a little more optimistic in that, it hinted at 7 rate cuts in the year 2024 itself, while the CME Fedwatch was yet to crystallize its thoughts on 2025. 

What the markets are likely to be a little more aggressive in its expectations, the minutes of the Fed meeting announced on January 03, 2024 were relatively disappointing. The markets were expecting the Fed to lay out a clear timeline for rate cuts and was also expecting some front-ending of rate cuts considering the sharp fall in the PCE inflation and the relatively strong GDP growth. While the minutes clearly indicated that the US economy had managed a soft landing, there was not the slightest hint of when the Fed would commence the rate cuts and how intense it would be. That was disappointing!

Four major highlights of the Fed December meeting minutes

The reaction of the market to the Fed minutes was apparently cold with the Dow and the NASDAQ indices falling sharply in the aftermath of the minutes announcement. Here are 4 key things that stood out about the minutes published on January 03, 2024.

• There was still uncertainty over the trajectory of rates. The best the Fed officials did was to hint that they were in favour of interest rate cuts in 2024. To quote market sceptics, “There was an unusually elevated degree of uncertainty about when the rate cuts would commence and what would be the intensity.” In fact, the minutes did not even indicate that the rate cuts would start in this year, leading market analysts to wonder if the CME Fedwatch was being unnecessarily optimistic about rate cuts in 2024.

   

• What surprised the markets was that while the Fed was extremely decisive about rate trajectory on the way up, it appears to be too ambivalent on the way down. The markets are now sensing that the Fed may trying to play it too safe, as they are still worried about dissipating the good work done on the inflation front. That actually led the market indices across the US and Asia to go soft in the aftermath of the minutes.

   

• One thing that came out clearly in the Fed minutes was that the soft landing of the economy was on track. There were concerns that the battle against inflation may result in a sharp deceleration in the US economy. That has not happened and that is good news. However, the minutes also indicate that the risk of growth reversing and high demand supporting high inflation were real.

   

• One geopolitical risk that the minutes underlined was the worsening situation in West Asia. Already, Houthi rebels in Yemen have escalated the crisis in the Red Sea while recent attacks in Lebanon (allegedly engineered by Israel) could internationalize the war far beyond the borders of Israel and Palestine.

Overall, there is a sense of disappointing in the markets that the Fed was not forthcoming about the timetable and the intensity of rate cuts in the year 2024.

Is the CME Fedwatch overestimating the rate cut scenario?

One way to look at the Fed outlook from a market perspective is the CME Fedwatch, which captures probabilities of rate levels after each Fed meet over next 1 year. One big question after the minutes is; is whether the CME Fedwatch is just being too optimistic.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	8.8%	91.2%
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	6.1%	66.5%	27.4%
May-24	Nil	Nil	Nil	Nil	Nil	Nil	5.1%	56.5%	33.8%	4.5%
Jun-24	Nil	Nil	Nil	Nil	Nil	5.1%	55.8%	34.1%	4.9%	0.1%
Jul-24	Nil	Nil	Nil	Nil	4.4%	49.7%	36.8%	8.5%	0.7%	Nil
Sep-24	Nil	Nil	Nil	4.1%	46.1%	37.8%	10.7%	1.3%	0.1%	Nil
Nov-24	Nil	Nil	2.7%	32.1%	40.5%	19.7%	4.4%	0.5%	Nil	Nil
Dec-24	Nil	2.2%	26.3%	38.9%	23.8%	7.4%	1.2%	0.1%	Nil	Nil

Data source: CME Fedwatch

The CME Fedwatch has certainly toned down its expectations of rate cuts, but not by too much. For instance, until the previous week, the CME Fedwatch was betting on 175 bps of rate cuts in 2024 and that has now been toned down to 150 bps of rate cuts in the current calendar year. Also, the rate cut expectations have been back-ended by the CME Fedwatch. In the previous week, the CME Fedwatch was expecting the Fed to aggressively start cutting rates from the January meeting itself, but now it expects most of the rate cuts to happen in the second half of the year. Otherwise, its overall expectations of rate cuts have come down by 25 bps post the Fed minutes.

However, the fact is that there is still divergence. The Fed has guided for just 3 rate cuts in 2024 while the CME Fedwatch is expecting 6 rate cuts to happen. Also, the CME Fedwatch is now expecting the Fed to start cutting rates from the March policy meet, while the latest minutes of the Fed have not even given the slightest indication that the Fed wants to cut rates in 2024, leave alone giving any guidance of the trajectory and intensity. For now, a lot will depend on the contents of the January Fed meeting statement. If continues to display ambivalence on rate cuts in January meeting also, then we could have the CME Fedwatch converging more towards the Fed point of view. The only redeeming features is that there appears to be consensus that, on the upside, rate hikes may be done and dusted for now.

What we read from the minutes of the December Fed meet

The minutes of the Fed meeting did not give away much into what the Fed is thinking. Here are some major things of interest we read in the Fed minutes pertaining to the December meeting of the Federal Open Markets Committee (FOMC).

1. It may be recollected that the Fed had held the rates in the existing range of 5.25% to 5.50% in the December Fed meeting. However, what emerges from the Fed minutes sit that there is a high level of uncertainty over how, or if, such rate cuts will happen. This does put the markets in a quandary since the Fed statement in December appeared to clearly indicate a timetable for 3 rate cuts in 2024 and 4 rate cuts in 2025.

    

2. However, the Fed minutes have indicated that the policy rate was at or very close to the peak. Logically, with PCE inflation veering towards 2% and growth robust at 2.6% projected for 2024, there is no strong reason for the Fed to even consider rate hikes at this juncture. This is almost an indication that rate hikes are done for the time being.

    

3. The Fed statement has specifically said that the sharp fall in core inflation over the last one year indicates that the supply chain bottlenecks that came about post the pandemic, were largely under control. However, the strength of the labour market is still a challenge and that does not to ease meaningfully for now, so inflation risk stays.

    

4. The Dot-Plot showing individual member expectations of interest rates, shows that the participants expected rate cuts over the coming 3 years to bring the overnight borrowing rate back down near the long-run range of 2%. However, that may not be a very great solace to the markets, which was actually expecting the Fed to have laid out a detailed time table for the trajectory of rate cuts in its policy minutes.

    

5. The Fed continues to play it too safe by referring to the “unusually elevated degree of uncertainty” about the policy path. In fact, one section of the members suggested that it might be necessary to keep the Fed rates at an elevated level if inflation shocks were to return to the US economy. The more hawkish members of the FOMC even indicated that the Fed should be open to rate hikes should the conditions evolve accordingly. 

    

6. Surprisingly, the minutes were also cautious and preferred to dwell on the data driven approach rather than sticking its neck out on the rate cut timetable. In fact, the minutes even reaffirmed that it would be appropriate for the policy to maintain a restrictive stance for some time until inflation gave hints of moving down sustainably.

    

7. While highlighting the victory in controlling inflation, the Fed has also pointed out that the recovery has not been even. For example, if you break up the inflation movement; you can see that energy and core goods inflation is clearly moving lower but the inflation in core services is still moving higher.

    

8. Updating the markets on the progress of the tapering of the bond book of the Federal Reserve, the minutes highlighted that the central bank had shaved off about $1.2 trillion of bonds by allowing maturing proceeds to roll off rather than reinvesting them as usual. This has, probably, reduced the need to hike rates and anywhere between 25 bps and 50 bps of rate cuts were saved due to the bond book unwinding. 

    

9. However, not all was disappointing about the Fed minutes, if one read deeper into the gist of the minutes. For instance, while the minutes may not have provided any direct clues about when rate cuts might commence, they reflected a growing sense that inflation is under control. In addition, the minutes also expressed growing concerns about the risks that ‘overly restrictive’ monetary policy may pose to the US economy. That can be interpreted as a signal that the Fed was serious about rate cuts.

    

10. Last, but not the least, there were favourable indications in the minutes about the diminishing risk of inflation. For instance, the core personal consumption expenditures price index on a six-month basis up to November just ran below the Fed’s 2% target. This was also the first time that Fed members avoided using the term ‘unacceptably high’ to describe inflation.

What disappointed the market in the final analysis was the absence of a start signal. The minutes shed very little direct light on when rate cuts might commence. The minutes clearly noted that any forthcoming policy decisions would be careful and data-dependent. Looking at the kind of uncertainty in the last 4 years, you really cannot hold that against the Fed.

What does the Fed statement mean for the RBI?

RBI effected its last rate hike in February and kept rates on hold over the next 5 MPC meetings in April, June, August, October, and December 2023. The good news for the RBI is that the consumer inflation, despite the bump up on November to 5.5%, is structurally under control. For the Indian economy, what does away with immediate risks to inflation is that the core inflation is sharply lower than it was a few months back. With robust GDP numbers and strong core sector growth, the RBI has less to really worry on the growth front.

With RBI holding status quo on repo rates since February 2023, it almost looks like rate hikes are done and dusted. The latest minutes of the Fed are unlikely to change that stance beyond a point. What the RBI would focus on is on the Fed statement and not so much on the interpretation of the minutes. After all, the Fed statement in December had made a distinctly dovish shift. Whether that induces the RBI to also change its monetary stance and start talking about rate cuts in coming policy, remains to be seen. However, that may not happen for the time being, despite rates being much higher than the pre-COVID levels.