Inflation debate dominates Fed March 2024 Minutes; rate cuts ambivalent

12 Apr 2024 , 10:18 AM

FED MARCH 2024 MINUTES AND CPI INFLATION

For the US economy, it was a sort of lethal combination. The minute of the March FOMC meeting were released on April 10, 2024, the same day that the BLS also released its consumer inflation report for the month of March. Of course, the minutes pertain to the FOMC (Federal Open Markets Committee) held on March 19 and 20, 2024, culminating in the release of the Fed statement on March 20, 2024. The minutes published on April 10, 2024 were merely a recording of the key highlights of the Fed meeting held 21 days ago. However, the coincidence was not missed. The minutes were announced on the same day the consumer inflation also came in sharply higher at 3.5% for the month of March 2024.

Even before the minutes were announced, the markets had already been taken aback by the sharp spike in consumer inflation. For the month of March 2024, the consumer inflation came in 30 bps higher at 3.5%. That does away with any immediate hopes of rate cuts, irrespective of what the Fed minutes said or implied. One must look at the consumer inflation number from a slightly longer perspective. In January 2024, the consumer inflation was expected at 2.9%, but came in at 3.1%. February inflation edged up by 10 bps to 3.2%, while the March inflation spiked by 30 bps to 3.5%. As the Fed had apprehended, the inflation impact of the Red Sea crisis was proving to be a lot more intractable than imagined.

CIRCA FED MARCH MEET – OUR 6 KEY READINGS

It is interesting how much things can actually change in a short span of 3 weeks. When the Fed statement was made by Jerome Powell on March 20, 2024, the indication was that the Fed would still go ahead with 3 rate cuts in 2024. However, the statement was not too explicit about when the rate cuts would start, or what would be the timetable. Here are 6 key points we gathered from the Fed statement issued on March 20, 2024.

• The Federal Reserve held rates steady at the range of 5.25%-5.50%, but hinted that 3 rates would still happen in calendar 2024. There was no commitment on a timetable for the rate cuts but, ostensibly, the rate cuts were to begin in June or July 2024. In the last few days, even the CME Fedwatch is veering towards just 2 rate cuts in 2024.
• For Jerome Powell the issue was not about cutting rates, but about the data being in sync such that the rate cuts could be justified. The 3 rate cuts did look more like a statement of intent, than a commitment to the markets. When the Fed talked about the data being in sync, it meant that inflation should be decisively moving towards 2%, while GDP growth and labour data should be soft enough to justify rate cuts. As of date, none of these conditions are being satisfied with any degree of conviction.
• Reading between the lines of the Fed statement, it was apparent that the Fed was actually more than willing to hold rates at elevated levels for a longer period. The dot plot was indicating a gradual and phased cut in rates. Fed dot plot had pegged 3 rate cuts in 2024 and another 3 rate cuts in 2025 (1 less than the original estimate).
• Fed was ambiguous on the timing of rate cuts in 2024 as there was no ambiguity about the inflationary triggers. PCE inflation had been persistently trending lower, but could now likely to follow the consumer inflation higher. Fed, also, did not find the inflation data convincingly journeying towards the 2% mark.
• The moral of the statement was that if the Fed had the luxury of waiting longer to cuts rates, then it would wait. That was evident from the speeches of other FOMC members like Chris Waller and Michelle Bowman. The US economy was seeing robust GDP growth. With risk of hard landing almost obviated, Fed could afford to wait and watch for now.
• Finally, the pace of balance sheet unwinding may have slackened, but it was still happening. The US Fed bond book had wound down by $1.70 Trillion between mid-2022 and early 2024. Despite hints of slowing bond unwinding in the Jan-24 meeting, the Mar-24 Fed meet did not contain any indications to that effect.

In a nutshell, the Mar-24 Fed statement did reiterate end of rate hikes and the possibility of 3 rate cuts in 2024. However, markets are increasingly sceptical about the second part.

FED MINUTES AND INFLATION MAKE CME FEDWATCH LESS DOVISH

The table below captures the rate cut probabilities over the next 10 Fed meetings, based on the implied probabilities in the Fed futures trading.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.1%	95.9%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.7%	19.1%	80.2%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	0.2%	6.4%	38.1%	55.3%
Sep-24	Nil	Nil	Nil	Nil	Nil	0.1%	3.0%	20.7%	45.8%	30.4%
Nov-24	Nil	Nil	Nil	Nil	Nil	0.8%	7.4%	26.9%	41.9%	23.0%
Dec-24	Nil	Nil	Nil	Nil	0.4%	4.4%	17.8%	34.6%	31.8%	11.0%
Jan-25	Nil	Nil	Nil	0.2%	1.8%	8.9%	23.6%	33.7%	24.7%	7.1%
Mar-25	Nil	Nil	0.1%	0.9%	5.1%	15.7%	28.2%	29.5%	16.6%	3.9%
Apr-25	Nil	Nil	0.3%	2.1%	8.0%	19.2%	28.7%	26.0%	13.0%	2.7%
Jun-25	Nil	0.1%	4.0%	4.6%	12.7%	23.2%	27.6%	20.5%	8.6%	1.6%

Data source: CME Fedwatch

Is it true that the CME Fedwatch has turned less dovish post the Fed minutes and March consumer inflation announcement by the BLS? Here are some key takeaways.

• Post the consumer inflation reading and the Fed minutes, the CME Fedwatch is assigning 76% probability to just 2 rate cuts in the year 2024 with a probability of just 24% to 3 rate cuts by end of 2024. The CME Fedwatch is looking at a best case scenario of 4 rate cuts in all by June 2025, which is much slower than what the Fed had originally hinted at.
• Some of the critical probabilities changed substantively post the US consumer inflation data and the Fed minutes. Just to illustrate, There is a huge dichotomy about the start of the rate cuts, post the recent data flows. For instance, prior to the inflation announcement, there was just 9.3% probability that rates would stay static till September 2024. Now that probability has gone up to 30.4%.
• Before the inflation data and the Fed minutes on April 10, 2024, the CME Fedwatch had assigned a 74% probability for rate cuts commencing in July 2024. Post the inflation data and the minutes of the Fed meet, that probability has come down to just 45%. CME Fedwatch is a lot less optimistic about the timing and size of rate cuts in 2024.

Having seen the market impact, let us turn to what the minutes of the Fed meeting actually indicated.

READING BETWEEN THE LINES OF THE MARCH 2024 FED MINUTES

The minutes of the FOMC meet largely maintained its cautious stance on rates, even while reassuring the markets that rate cuts were still on the cards. Here is a quick dekko

• Reading through the minutes, it is evident that Federal Reserve officials remain deeply concerned that inflation was not moving lower quickly enough. As a statement of intent, the Fed members still underlined that the Fed was open to cutting rates at some point later in 2024; although that was as ambiguous as ambiguous could be. The concern was that while the secular trend was down, the last mile inflation control was proving to be much trickier than originally envisaged.
• The broad message from the Fed minutes was that the Fed would not be cutting the benchmark rates till it had gained greater confidence that inflation was on a steady path back to the Federal Reserve’s 2% annual target. The minutes also reiterated that recent data from PCE inflation, CPI inflation, labour & wages data as well as the GDP data had not increased their confidence that inflation was moving towards 2% level.
• Not surprisingly, the minutes indicate that a disproportionate amount of time was spent by the FOMC members discussing inflation. Fed officials have conceded that the recent geopolitical turmoil and rising energy prices were potent risks that could push inflation higher. The fear was that looser monetary policy could add to price pressures. Inflation pressures were partially offset by the impact of improved technology.
• The minutes also suggested that the higher-than-expected inflation readings in January and February 2024 could possibly be attributed to seasonal factors, which could autocorrect in the coming months. However, the FOMC members were broadly divided on this issue. The eventual consensus was that inflation was broad-based and hence could not be dismissed as a mere statistical aberration.
• The Fed clearly wants greater confidence triggers that inflation was decisively and inexorably moving toward the 2% target. The recent inflation reading has only validated these concerns, especially after the CPI inflation for March 2024 came in sharply higher by 30 bps at 3.5%, largely led by energy inflation. However, food inflation and core inflation were flat, indicating that it was more of the fuel deflation unwinding.
• The intent of Fed remained clear, but the action plan was, perhaps, deliberately ambiguous. The Fed minutes indicated that most participants estimated it would be appropriate to move policy to a less restrictive stance at some point in 2024. However, that would be subject to the macro data like inflation moving lower and GDP growth and labour data being in sync with lower levels of inflation. Currently, the disinflation process was on a path that was a little more erratic than originally envisaged.
• Even on the balance sheet unwinding, the stance of the Fed minutes was relatively ambiguous. After the bond book had been compressed by nearly $1.70 Trillion, Fed officials hinted at going slow on the winding down. However, no timetable was forthcoming in this case also. For instance, the Fed did mention that the easing of the unwinding would happen as the roll-off is reduced to half the current size. Once again, the Fed restricted itself to saying that the process would start “fairly soon” without committing to specific timelines.

Following the release of consumer inflation and the Fed minutes, traders in the fed funds futures market recalibrated their expectations. Now markets are pegging that the first rate cut would only happen in September 2024, with a higher probability of 2 rate cuts in 2024, instead of 3 rate cuts. The minutes did not betray any such commitment, but the CME Fedwatch has given sufficient indications. The only consensus in the minutes was that the situation warranted a cautious approach.

HOW WILL RBI INTERPRET THE FED MAR-24 MINUTES?

RBI effected its last rate hike in February 2023 and has since held rates static for the next 7 meetings, including the recent April RBI MPC meeting. India consumer inflation fell from 5.69% in December 2023 to 5.1% in January 2024 and further to 5.09% in February 2024. The March CPI inflation would be announced by MOSPI on April 12, 2024 and it is expected to come in below 5%. However, this could be partially attributed to the cut in petrol and diesel prices by ₹2/litre. The RBI finds itself in a sweet spot with GDP growth robust at over 8% in the first three quarters of FY24 and likely to edge past 8% for fiscal year FY24.

One thing is certain; rate hikes are now a thing of the past. However, there is a strong case for the RBI to cut rates. Firstly, repo rates at 6.5% are 135 bps above the pre-COVID interest rates. Secondly, if you look at the 10-year benchmark bond yields of 7.12%, it offers a real rate of over 2%; which is unsustainably high. While the Fed has not committed anything in the minutes, the CME Fedwatch is pegging the first rate cut only in September 2024. By then, India would have completed its election, government formation and full budget. That is enough time for the RBI to start worrying about monetary divergence risks.