Gold, Wall Street stumbled from the Fed’s dovish hold high

On Wednesday all focus of the market was on the Fed’s policy decision, where the Fed was expected to hold the rate with a confirmation of QT tapering (?) and an indication of rate cuts in the ‘later part of the year’; i.e. less dovish hold. Accordingly, Fed/Powell indicated no rush for an imminent rate cut in May (at least) and also indicated active discussion of QT tapering talk in March. Overall it’s a hawkish hold or less dovish hold by the Fed.

On Wednesday, the U.S. Fed held all primary policy rates for a 5th consecutive meeting as unanimously expected; i.e. the target range for the Federal Fund's Rate (FFR-interbank rate) at +5.38% (median of 5.25%-5.50%); primary credit rate (repo rate) at +5.50%; IOER (reverse repo rate) at +5.40%; overnight repurchase agreement rate (RP) at +5.50% and RRP (Overnight Reverse Repurchase Agreement Rate) at +5.30%, keeping U.S. borrowing costs to the highest level since January 2001 (23-years).

As US core CPI inflation is still quite elevated at around +4.00% (6M rolling average), while the unemployment rate around 3.8% (6M Rolling average) is hovering just below Fed’s longer-term sustainable target of 4.0%, there is still a need for a higher (restrictive) for longer policy stance, which may further restrict economic activities and demand, helping to match with the present constrained supply side of the economy and bring down inflation further in the process towards +2.0% targets on a sustainable basis.

In its March SEP/dot-plots, the Fed projected a -75 bps rate cut each in 2024, 2025, and 2026 and a -50 bps rate cut in 2027 (longer term) for indicative repo rate to 4.75%, 4.00%, 3.25% and 2.75% terminal rate from present 5.50%. This is against Dec’24 SEP/Dot-plots of -75 bps, -100bps, -75 bps and -25 bps rate cuts projections for 2024, 2025, 2026 and 2027 (longer term) to 4.75%, 3.75% 3.00% and 2.75% terminal rate. Thus although, the Fed projected the same rate cuts for 2024 and lower rate cuts for 2025, eventually indicated the same levels of terminal repo rate at +2.75% for the longer term against pre-COVID levels of +2.50%.

Similarly, in its Mar’24 SEP, the Fed projected US real GDP growth for 2024 at 2.1% vs 1.4% in the December projection; 2.0% vs 1.8% for 2025 and 2.0% vs 1.9% for 2026. Headline PCE inflation forecasts were kept unchanged for 2024 (2.4% vs 2.4%) but were raised for 2025 (2.2% vs 2.1%). Fed projected the core PCE inflation higher for 2024 (2.6% vs 2.4%) while leaving it unchanged for 2025 at 2.2%. The unemployment rate is seen lower at 4% in 2024 (vs 4.1%) but projections were kept unchanged at 4.1% for 2025. Fed always maintains that although shorter-term (6-12M) SEP/dot-plots may be relevant or most likely to happen, longer-term SEPs are not and are always subject to some revision as per actual economic data.

Overall, the latest Mar’24 SEP/dot-plots were slightly hawkish than earlier Dec’23 as the Fed projected higher core PCE inflation for 2024 and 2025 with lower rate cuts for 2025, keeping the same unchanged for 2024.

Full text of Fed’s statement: 20th Mar’24- Federal Reserve issues FOMC statement

“Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have remained strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee judges that the risks to achieving its employment and inflation goals are moving into better balance. The economic outlook is uncertain, and the Committee remains highly attentive to inflation risks.

In support of its goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.

In addition, the Committee will continue reducing its holdings of Treasury securities agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Thomas I. Barkin; Michael S. Barr; Raphael W. Bostic; Michelle W. Bowman; Lisa D. Cook; Mary C. Daly; Philip N. Jefferson; Adriana D. Kugler; Loretta J. Mester; and Christopher J. Waller.”

Implementation Note issued March 20, 2024: Decisions Regarding Monetary Policy Implementation

The Federal Reserve has made the following decisions to implement the monetary policy stance announced by the Federal Open Market Committee in its statement on March 20, 2024:

The Board of Governors of the Federal Reserve System voted unanimously to maintain the interest rate paid on reserve balances at 5.4 percent, effective March 21, 2024.

As part of its policy decision, the Federal Open Market Committee voted to direct the Open Market Desk at the Federal Reserve Bank of New York, until instructed otherwise, to execute transactions in the System Open Market Account in accordance with the following domestic policy directive:

"Effective March 21, 2024, the Federal Open Market Committee directs the Desk to:

Undertake open market operations as necessary to maintain the federal funds rate in a target range of 5-1/4 to 5-1/2 percent.

Conduct standing overnight repurchase agreement operations with a minimum bid rate of 5.5 percent and with an aggregate operation limit of $500 billion.

Conduct standing overnight reverse repurchase agreement operations at an offering rate of 5.3 percent and with a per-counterparty limit of $160 billion per day.

Roll over at auction the amount of principal payments from the Federal Reserve's holdings of Treasury securities maturing in each calendar month that exceeds a cap of $60 billion per month. Redeem Treasury coupon securities up to this monthly cap and Treasury bills to the extent that coupon principal payments are less than the monthly cap.

Reinvest into agency mortgage-backed securities (MBS) the amount of principal payments from the Federal Reserve's holdings of agency debt and agency MBS received in each calendar month that exceeds a cap of $35 billion per month.

Allow modest deviations from stated amounts for reinvestments, if needed for operational reasons.

Engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve's agency MBS transactions."

In a related action, the Board of Governors of the Federal Reserve System voted unanimously to approve the establishment of the primary credit rate at the existing level of 5.5 percent.

This information will be updated as appropriate to reflect decisions of the Federal Open Market Committee or the Board of Governors regarding details of the Federal Reserve's operational tools and approach used to implement monetary policy.”

Full text of Fed Chair Powell’s opening statement: 20th Mar’24

My colleagues and I remain squarely focused on our dual mandate to promote maximum employment and stable prices for the American people. The economy has made considerable progress toward our dual mandate objectives. Inflation has eased substantially while the labor market has remained strong, and that is very good news. But inflation is still too high, ongoing progress in bringing it down is not assured, and the path forward is uncertain. We are fully committed to returning inflation to our 2 percent goal. Restoring price stability is essential to achieve a sustainably strong labor market that benefits all.

Today, the FOMC decided to leave our policy interest rate unchanged and to continue to reduce our securities holdings. Our restrictive stance on monetary policy has been putting downward pressure on economic activity and inflation. As labor market tightness has eased and progress on inflation has continued, the risks to achieving our employment and inflation goals are moving into better balance. I will have more to say about monetary policy after briefly reviewing economic developments.

Recent indicators suggest that economic activity has been expanding at a solid pace. GDP growth in the fourth quarter of last year came in at 3.2 percent. For 2023 as a whole, GDP expanded by 3.1 percent, bolstered by strong consumer demand as well as improving supply conditions. Activity in the housing sector was subdued over the past year, largely reflecting high mortgage rates. High-interest rates also appear to have weighed on business fixed investment.

In our Summary of Economic Projections, Committee participants generally expect GDP growth to slow from last year’s pace, with a median projection of 2.1 percent this year and 2 percent over the next two years. Participants generally revised their growth projections since December, reflecting the strength of incoming data, including data on labor supply.

The labor market remains relatively tight, but supply and demand conditions continue to come into better balance. Over the past three months, payroll job gains averaged 265 thousand jobs per month. The unemployment rate has edged up but remains low, at 3.9 percent. Strong job creation has been accompanied by an increase in the supply of workers, reflecting increases in participation among individuals aged 25 to 54 years and a continued strong pace of immigration.

Nominal wage growth has been easing, and job vacancies have declined. Although the jobs-to-workers gap has narrowed, labor demand still exceeds the supply of available workers. FOMC participants expect the rebalancing in the labor market to continue, easing upward inflation pressure. The median unemployment rate projection in the SEP is 4.0 percent at the end of this year and 4.1 percent at the end of next year.

Inflation has eased notably over the past year but remains above our longer-run goal of 2 percent. Estimates based on the Consumer Price Index and other data indicate that total PCE prices rose 2.5 percent over the 12 months ending in February; and that, excluding the volatile food and energy categories, core PCE prices rose 2.8 percent.

Longer-term inflation expectations appear to remain well anchored, as reflected in a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets. The median projection in the SEP for total PCE inflation falls to 2.4 percent this year, 2.2 percent next year, and 2 percent in 2026.

The Fed’s monetary policy actions are guided by our mandate to promote maximum employment and stable prices for the American people. My colleagues and I are acutely aware that high inflation imposes significant hardship as it erodes purchasing power, especially for those least able to meet the higher costs of essentials like food, housing, and transportation. We are strongly committed to returning inflation to our 2 percent objective.

The Committee decided at today’s meeting to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent and to continue the process of significantly reducing our securities holdings. As labor market tightness has eased and progress on inflation has continued; the risks to achieving our employment and inflation goals are coming into better balance.

We believe that our policy rate is likely at its peak for this tightening cycle and that, if the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year. The economic outlook is uncertain, however, and we remain highly attentive to inflation risks. We are prepared to maintain the current target range for the federal funds rate for longer, if appropriate.

We know that reducing policy restraint too soon or too much could result in a reversal of the progress we have seen on inflation and ultimately require even tighter policy to get inflation back to 2 percent. At the same time, reducing policy restraint too late or too little could unduly weaken economic activity and employment.

In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably down toward 2 percent. Of course, we are committed to both sides of our dual mandate, and an unexpected weakening in the labor market could also warrant a policy response. We will continue to make our decisions meeting by meeting.

In our SEP, FOMC participants wrote down their individual assessments of an appropriate path for the federal funds rate based on what each participant judged to be the most likely scenario going forward. If the economy evolves as projected; the median participant projects that the appropriate level of the federal funds rate will be 4.6 percent at the end of this year, 3.9 percent at the end of 2025, and 3.1 percent at the end of 2026—still above the median longer-term funds rate.  These projections are not a Committee decision or plan; if the economy does not evolve as projected, the path for the policy will adjust as appropriate to foster our maximum employment and price stability goals.

Turning to our balance sheet, our securities holdings have declined by nearly $1.5 trillion since the Committee began reducing our portfolio. At this meeting, we discussed issues related to slowing the pace of decline in our securities holdings. While we did not make any decisions today on this, the general sense of the Committee is that it will be appropriate to slow the pace of runoff fairly soon, consistent with the plans we previously issued.

The decision to slow the pace of runoff does not mean that our balance sheet will ultimately shrink by less than it would otherwise but rather allows us to approach that ultimate level more gradually. In particular, slowing the pace of runoff will help ensure a smooth transition, reducing the possibility that money markets experience stress and thereby facilitating the ongoing decline in our securities holdings consistent with reaching the appropriate level of ample reserves.

We remain committed to bringing inflation back down to our 2 percent goal and to keeping our longer-term inflation expectations well anchored. Restoring price stability is essential to set the stage for achieving maximum employment and price stability over the long term. To conclude, we understand that our actions affect communities, families, and businesses across the country. Everything we do is in service to our public mission. We at the Fed will do everything we can to achieve our maximum employment and price stability goals”.

Highlights of Fed Chair Powell’s comments in the Q&A: 20th Mar’24

·         The economy has made considerable progress, inflation has eased substantially

·         Ongoing progress is not assured though, the path forward is uncertain

·         GDP has been bolstered by strong consumer demand as well as healing supply chains

·         Risks to achieving Fed goals are moving into better balance

·         High-interest rates have weighed on businesses' fixed-income investment

·         Supply and demand are coming into better balance

·         Labor demand still exceeds labor supply, and GDP forecasts were revised higher because of data on labor supply

·         FOMC participants expect a rebalancing in the labor market to continue

·         Nominal wage growth has been easing

·         Inflation expectations remain well-anchored

·         The FOMC participants expect rebalancing in the labor market to continue

·         Risks to dual mandate goals coming into better balance

·         Our policy rate is likely at its peak

·         We're likely to cut rates at some point this year, but the outlook is uncertain and we remain attentive to risks

·         We are prepared to keep rates high longer if needed

·         We need greater confidence inflation is moving sustainably down before we cut rates

·         Unexpected weakness in the labor market could warrant a response too even between scheduled meetings

·         On the balance sheet, we discussed issues related to the slowing pace of decline in holdings, our general sense is we will start running off fairly soon

·         A slowing pace of runoff will ensure a smooth transition

·         Inflation data came in a little bit higher than expected

·         The projections do not mean higher tolerance for inflation

·         There's some confidence that lower market rent increases in housing will show up over time, I'm just not sure when that will be

·         I assume we will continue to see goods prices continue into a new equilibrium

·         The risks are two-sided now

·         The first-rate cut is consequential

·         January CPI and PCE numbers were quite high but could have been due to seasonal adjustments; February was also high, but not terribly

·         Those January and February inflation numbers did not add to our confidence

·         We are not going to overreact to these two months of data, nor ignore them

·         We want to see more data that gives us higher confidence in inflation moving down sustainably

·         Risks are moving into a better balance

·         The economy is performing well

·         If there were a significant weakening in the labor market, that would be a reason to start rate cuts

·         Lower inflation or weaker jobs data could drive rate cuts

·         I don't think we know if rates are going to be higher in the longer run

·         My instinct is rates won't go back down to the very low levels we saw before, but there is tremendous uncertainty around that

·         It is still likely in most people's view that we will have rate cuts this year, but it depends on the data

·         I'm looking for data confirming low-inflation data from last year

·         Strong hiring all by itself would not be a reason to hold off on rate cuts

·         In the labor market, if we are getting a lot of supply and demand, you could potentially have a bigger economy where inflation pressures are not increasing

·         Ultimately, we do think financial conditions are weighing on economic activity

·         We tend to see a little bit stronger inflation in the first half of the year

·         Many saw possible seasonal problems in the January inflation print

·         We don't know if this is a bump on the inflation road, or something more

·         We need to take time to assess if recent inflation represents more than bumps in the road

·         I'm looking for data confirming low-inflation data from last year

·         It is still likely in most people's view that we will have rate cuts this year, but it depends on the data

·         Lower inflation or weaker jobs data could drive rate cuts

·         I don't think we know if rates are going to be higher in the long run

·         My instinct is rates won't go back down to the very low levels we saw before

·         We want to see more data that gives us higher confidence in inflation moving down sustainably, but there is tremendous uncertainty around that

·         If there were a significant weakening in the labor market, that would be a reason to start rate cuts

·         There is good ongoing progress in disinflation despite some hiccups and slightly higher projections of core inflation in the SEP; the Fed is on the way to cut rates in the coming months as per given projections

·         Overall, inflation will come down to around 2% led by a fall in housing service and non-housing service inflation

·         Fed is trying to ensure timely rate cuts (not too soon or too late) to ensure the goldilocks nature of the US economy

·         Fed will not react on two months of relatively higher inflation data in Jan-Feb’24, which may be distorted due to various seasonal factors/adjustments; usually, the Fed considers a 6-12M rolling average of data for any policy change

·         “We'll take, things can happen during an inner meeting period if you look back, unexpected things. So, I don't want to, I wouldn't want to dismiss anything. So, I just would say that the Committee wants to see more data that gives us higher confidence that inflation is moving down sustainably toward two percent. I also mentioned that we don't see this in the data right now, but if there were a significant weakening in the data, particularly in the labor market, that could also be a reason for us to begin the process of reducing rates again. I don't, there's nothing in the data pointing at that but those are the things that we'll be looking at coming meetings and without trying to refer to any specific meeting”

·         Although the Fed projected +25 bps higher neutral/terminal rate in the longer run (after 2026), it’s not sure about the neutral rate levels in the current economic scenario, but it may be higher than pre-COVID levels due to some change in demography and higher productivity

·         Fed is getting some confidence it will get necessary confidence in H2CY24 that inflation will sustainably move towards +2% targets as per SEP projections so that the Fed can cut rates as indicated in the SEP/DOT-PLOTS for 2024-25-26 and longer run (2027)

·         “I think if you look at the SEP, what it says is that it is still likely in most people's view that we will achieve that confidence and that there will be rate cuts. But that's going to depend on the incoming data, it is. The other thing is, in the second half of the year you have some pretty low readings so it might be harder to make progress as you move that 12-month window forward. Nonetheless, we're looking for data that confirm the kind of low readings that we had last year and give us a higher degree of confidence that what we saw was inflation moving sustainably down to two percent, toward two percent”

·         In 2023, inflation came down despite a strong job market and subsequently strong/higher demand as the supply side also expanded in terms of labor force (mainly due to immigration) and also in terms of higher goods & services

·         “So I see the Committee looking at the two months of data and asking the same question you're asking, and saying we're just going to have to see what the data show. As I mentioned, you can look at January, which is a very high reading and you can, and I think many people did see the possibility of seasonal adjustment problems there, but again, you don't want to-- you've got to be careful about dismissing the parts of the data that you don't like. So, then February wasn't as high, but it was higher”

·         “So the question is what are we going to see? We tend to see a little bit stronger, this is in the data, a little bit stronger inflation in the first half of the year, a little bit less strong later in the year. We're going to, we're going to let the data show-- don't think we know whether this is a bump on the road or something more. We'll have to find out. In the meantime, the economy is strong, the labor market is strong, and inflation has come way down, and that gives us the ability to approach this question carefully and feel more confident that inflation is moving down sustainably at two percent when we take that step to begin dialing back our restrictive policy”

·         “It certainly hasn't improved our confidence. It doesn't raise anyone's confidence, but I would say that the story is essentially the same and that is of inflation coming down gradually toward two percent on a sometimes bumpy path, as I mentioned. I think that's what you still see. We've got nine months of 2-1/2 percent inflation (around +0.20% sequentially annualized) now and we've had two months of kind of bumpy inflation (around +0.40% sequential rate). We were saying that we'll, it's going to be a bumpy ride. We consistently said that”

·         “Now here are some bumps and the question is; are they more than bumps? And we just don't, we can't know that. That's why we are approaching this question carefully, it is very important for everyone that we serve that we do get inflation sustainably down and I think the historical record, it's every situation is different, but the historical record is that you need to approach that question carefully and try to get it right the first time and not have to come back and raise rates again perhaps if you cut inappropriately, prematurely”

·         Fed will continue to stick to its dual mandate of price stability (2% inflation on a sustainable basis), maximum (inclusive/broad-based) employment (below 4% unemployment rate on a sustainable basis) along with ensuring financial stability irrespective of comments/letter by various Lawmakers (Congressional Members/Senators) pressuring Fed/Powell to lower interest rate prematurely; Fed will continue to take Congress into confidence while sticking to its monetary policy it think as appropriate as per current economic data and evolving outlook

·         Fed appreciates thoughtful dissents and debates within FOMC for a wide range of views

·         The labor market is still very strong despite the headline unemployment rate ticked up to 3.9% in February, almost at 4.0% projection/longer term; The Fed looks at various indicators/data for job/labor market including labor force/supply, number of job postings/JOLTS (demand), wage growth trend, initial/continuing jobless claims and also layoffs/fresh hiring’s etc; Fed does not think there is a crack in the labor market yet despite some stories/articles in the financial media; but Fed is ready to take appropriate action (rate cuts) if it sees such/sudden deterioration in the labor market (even without waiting for inflation drifting lower further)

·         Fed is now internally discussing QT tapering and will announce it ‘fairly soon’ (by May meeting?); will ensure financial stability at all costs after taking a lesson from 2019 pre-COVID REPO/money/funding market disruption (as a result of lingering QT, liquidity/USD scarcity and higher bond yields), which caused SOFR (Secured Overnight Financing Rate) jumped to a day high above +10% from +2.43% before settling around +5.25% on 17th Sep’2019; then Fed again starts quash/small QE (QE/NOT QE) even before COVID; as an alternative, Fed has now standing REPO facility where any bank can borrow fund from Fed in lieu of normal interbank funding

·         “So that is (QT tapering) what we're discussing essentially is, and we're not discussing all the other many other balance sheet issues. We will discuss those in due course but what we're looking at is slowing the pace of runoff. There isn't much runoff among NBS, in NBS right now but there is in treasuries and we're talking about going to a slower pace. I don't want to give you a specific number because we haven't made a, haven't had an agreement or decision, but that's the idea. And that's what we're looking at. And in terms of the timing, I said fairly soon”

·         “I wouldn't want to try to be more specific than that, but you get the idea. The idea is, and this is in our longer-run plans, that we may be able to get to a lower level because we would avoid the kind of friction that can happen. Liquidity is not evenly distributed in a system and there can be times when in the aggregate, reserves are ample or even abundant. But not in every part, and those parts where they're not ample, there can be stress and that can cause you to prematurely stop the process to avoid the stress and then it would be very hard to restart we think, so something like that happened in '19 perhaps, so that's what we're doing, we're looking at what would be a good time and what would be a good structure and fairly soon is words that we use to mean, fairly soon”

·         Fed may later (after 2026-27 ?) gradually transit into a B/S comprising mainly longer-term treasuries instead of shorter duration/MBS bonds

·         “So that, our longer-run goal is to return to a balance sheet that is mostly treasuries. I do expect that once we're through this we'll come back to the other issues about the composition and the maturity and revisit those issues, but it's not urgent right now. We want to get this decision made first and then we can, when the time is right, come back to the other issues”

·         “We'll be watching carefully, but one of the reasons we're slowing down (QT), we will soon enough, fairly soon I should say, slow down, is that we want to avoid any kind of that turbulence. I wasn't thinking particularly about the banking sector turbulence, but we--and we had some indicators the last time. This is our second time doing this, and I think we're going to be paying a lot of attention to the things that started to happen and that foreshadowed what eventually happened at the end of that tightening cycle where we wound up in a short reserves situation. We don't want to do that again. And I think now we have a better sense of what are the indicators. It isn't, it wasn't so much in the banking system as it was around, for example, where federal funds are trading relative to the administered rates and where secured rates are relative to the administered rates. Those sorts of things-- We will always be watching the banking system for similar signs though”

·         “We broadly think that once the overnight repo stabilizes, either at zero or close to zero, that as the balance sheet shrinks we should expect that reserves will decline pretty close to dollar for dollar with that. That's what we think”

·         “So, it's sort of ironic that by going slower you can get farther, but that's the idea. The idea is that with a smoother transition, you won't, you'll run much less risk of kind of liquidity problems that can grow into shocks and can cause you to stop the process prematurely. So, that's-- in terms of how it ends, we're going to be monitoring carefully money market conditions and asking ourselves, what they're telling us about reserves. Are they, right now we would characterize them as abundant, and what we're aiming for is ample; And which is a little bit less than abundant”

·         “So there isn't a, there's not a dollar amount or a percent of GDP or anything like that where we think we have a pretty clear understanding that we're going to be looking at what these, what's happening in money markets in particular, a bunch of different indicators, including the ones I mentioned, to tell us when we're getting close. Then though, you reach a point ultimately where you stop allowing the balance sheet to run and you-- but then, from that point, there's another period in which non-reserves, non-reserve liabilities grow organically like currency, and that also shrinks the reserves at a very slow pace”

·         “So you have a slower pace of runoff, which we'll have fairly soon, then you have another time where you effectively hold the balance sheet constant and allow non-reserve liabilities to expand and then that ultimately brings you, ideally, in for-- brings it into a nice, easy landing at a level that is above, above what we think the lowest possible ample number would be. We're not trying for that, we want to have a cushion, a buffer, because we know that demand for reserves can be very volatile and we don't want to, again find ourselves in a situation where there aren't reserves. We have to turn around and buy assets and put reserves back in the banking system the way we did in 2019 and '20”

·         Fed needs more confidence about inflation coming down to 2% on a sustainable basis

·         “So we're most importantly we're looking at the incoming inflation data and the contents of it and what they're telling us. So, that'll be, and also the various components, so obviously that's what we want, we want more confidence that inflation is coming down sustainably toward two percent. And I mean of course we'll also be looking at all the other things that are happening in the economy, we'll look at the totality of the data, including everything essentially as we make that assessment, but the most important thing will be the inflation data coming in”

·         Fed watches wage inflation spiral closely, but doesn’t target wage directly; Fed thinks wage growth is still high but gradually coming down to be consistent with 2% inflation on a sustainable basis

·         “Wages is one thing. We don't, our target is not wages, it's inflation. But we would look to the fact that wages are still coming in very strong, but they've been, wage increases that's to say, wage increases have been quite strong, but they're gradually coming down to levels that are more sustainable over time. And that's what we want. We don't think that the inflation was originally caused, we think, I don't think, mostly by wages. That wasn't the story. But we do think that to get inflation back down to two percent sustainably, we'd like to see continuing gradual movement of wage increases at still high levels, but back down to levels that are more sustainable over time.

·         FOMC took a cautious approach regarding rate cut plans in the later part of the year after the sudden surge in core CPI/PCE sequential inflation data in January and February

·         “I guess I'd put it this way, if you look at the incoming inflation data that we've had for January and February, I think very broadly that suggests that we are right to wait until we're more confident. So I think, I didn't hear anyone dismissing it as not information that we should look at or anything like that. So I think generally speaking it does go in the direction of saying yes, it's appropriate for us to be careful as we approach this question”

·         Powell clarified that the Fed’s position about the ‘confidence’ level of inflation going down to 2% on a sustainable level is the same as per official statements/Q&A today and Powell’s Senate/Congressional testimony Q&A despite some apparent contradictions; although core inflation is cooling down gradually, especially from 2nd half of 2023, Fed needs more rapid disinflation to be confident enough for starting rate cut cycle; Fed is looking for H2CY24 for more disinflation (like in H2CY23)

·         “So let me say my main message at that, in those two days of hearings was really that the Committee needs to see more evidence to build our confidence that inflation is moving down sustainably toward our two percent goal and we don't expect that it will be appropriate to begin to reduce rates until we're more confident and that is the case, that that is the case. I said that any number of times so those were kind of the main part of the message. We repeated that today in our statement. I also, to the language you mentioned, I pointed out that we had made significant progress over the past year, and what we're looking for now is confirmation that that progress will continue. We had a series of inflation readings over the second half of last year that were much lower, we didn't overreact as I mentioned, but that's what I had in mind”

·         Although the Fed is projecting Feb’24 core PCE inflation at +2.8% going by available core CPI and PPI data/trend, the Fed is not confident that it will hit around +2.4% by summer (June/July); but the Fed is hoping for softer inflation number in 2nd part of the year (H2CY24) for the required confidence to go for rate cut cycle

·         “Well, we'll just have to see how the data come in. We would of course love to get great inflation data. We got really good inflation data on the second part of last year, again, we didn't overreact to it, we said we needed to see more and we said it would be bumpy and now we have January and February, which I've talked about a couple of times. So, we're looking for more good data and we would certainly welcome it”

Conclusions:

The 6M rolling average of US core inflation (PCE+CPI) is now around +3.6%. Fed may cut 75-100 bps in H2CY24 if the 6M rolling average of core inflation (PCE+CPI) indeed eased further to +3.0% by H1CY24.

As per Taylor’s rule, for the US:

Recommended policy repo rate (I) = A+B+(C-D)*(E-B)

=1.50+2.00+ (2.60-2.00)*(4.50.00-2.00) =1.00+2+ (0.60*2.50) = 3.00+1.50=4.50% (By Dec’24)

Here:

A=desired real interest rate=1.50; B= inflation target =2.00; C= Actual real GDP growth rate for CY23=2.6; D= Real GDP growth rate target/potential=2.00; E= average core CPI+PCE inflation for CY23=4.50

Fed may announce a plan for QT tapering/closing in the May meeting and should close the same before going for rate cuts in H2CY24. Fed, the world’s most important central bank may not continue QT (even at a reduced pace) and go for rate cuts at the same time as QT, and rate cuts are contradictory, although Fed/Powell kept the option open, at least theoretically.

Fed’s B/S size is now around $7.54T (as of 13th Mar’24), reduced from around $8.96T life time high scaled in Apr’22. Looking ahead, the Fed may maintain its B/S size around $7.00T, which would be 25% of the projected CY24 nominal US GDP of around $28T. Fed had indicated previously (before COVID) that B/S size is around 20% of nominal GDP.  In Sep’2019, QT tapering (started in 2017) caused B/S size to fall to around $3.77T from around $4.47T, which caused severe disruption in the US money/funding market, forcing the Fed to go for small QE even before COVID.

Now Fed’s QT rate is $95B/M; i.e. $0.095T/M; if Fed intends to keep its B/S size around $7.00T from the existing $7.54T, it needs around 5-6 more months at the same rate of $0.095T/M; i.e. by Aug’24, Fed may be able to reduce its B/S size to around $7.00T and stop the QT. In that scenario, the Fed may go for -75 bps rate cuts in September, November and December’24. By 18th September (Fed MPC date), the Fed will have complete data for core inflation and also unemployment/real GDP data till Aug/July’24 to have the required ‘higher confidence’ to go for rate cuts.

After the 2019 money/funding market crisis/disruptions caused by QT, the Fed introduced the ON RP/RRP lending facility (Overnight Repo and Reverse Repo Repurchase Agreement) to ensure financial stability even during QT periods, which generally causes less intention among big banks/MMFs (money market funds) to lend each other. Thus, this time QT was not disruptive like we saw in late 2019 causing some slide in Wall Street and making Trump furious against Fed/Powell.

Looking ahead, Fed may keep B/S size around $7.00T, at mid-2020 levels during COVID times to ensure financial/Wall Street stability along with Main Street stability (price stability and employment stability).

Ahead of the Nov’23 U.S. Presidential election, White House/Biden/Fed/Powell is more concerned about elevated inflation rather than the labor market; prices of essential goods & services are still significantly higher (around +20%) than pre-COVID levels, which is creating some incumbency wave (dissatisfaction) among general voters against Biden admin (Democrats).

Thus Fed is now giving more priority to price stability than employment (which is still hovering below the 4% red line) and is not ready to cut rates early as it may again cause higher inflation just ahead of the November election. Fed may hike only from Septenber’24, which will ensure no inflation spike just ahead of the Nov’24 election (as any rate action usually takes 6-12 months to transmit in the real economy), while boosting up both Wall Street and also Main Street (investors/traders/voters). Fed hiked rate last on 26th July’23 and may continue to be on hold till at least July’24; i.e. around 12 months for full transmission of its +5.25% cumulative rate hikes effect into the real economy.

Overall, the Fed’s mandate is to ensure price stability (2% core inflation), and maximum employment (below 4% unemployment rate) along with financial/Wall Street stability as well as lower borrowing costs for the government. As the US is now paying almost 15% of its tax revenue as interest on debt, the Fed will now not allow the 10Y US bond yield above 4.50-5.00% at any cost.

Bottom line:

Fed may not continue QT (even at a lower pace) and go for a rate cut cycle at the same time as these two policy actions are contradictory. Thus Fed may opt to first close the QT by Aug’24 at a B/S size of around $7.00T from the present $7.54T through the present pace of $0.095T/M. Then the Fed may go for rate cuts of -75 bps cumulatively in September, November and December’24 for +4.75% repo rates from the present +5.50%. Fed is now using ON RR/RRP for funding market stability, especially for smaller/regional US banks (around 10% of the US banking system), there is no visible effect of QT unlike during late 2019. Thus Fed may opt for direct QT closing at the present pace by Aug’24, keeping the B/S size around $7.00T, almost 25% of the estimated nominal GDP ($30T) by 2024.

Market wrap:

On Wednesday, Wall Street Futures and gold soared on hopes & hypes of an early Fed pivot/put. The market was expecting -100 bps Fed rate cuts in 2024 and 2025 each (from June 24) and QT tapering from June’24 to close the same by Dec’24. But going by the overall Fed/Powell statements, Q&A comments, trend of core inflation, and also the Nov’24 US Presidential Election, the Fed may go for -75 bps rate cuts in 2024 starting from September after closing the QT by Aug’24. Subsequently, Gold stumbled from around 2222 post-Fed early Thursday to almost 2157 Friday, while Wall Street Futures also slid. Dow Future stumbled from around 40316 to 39824, and NQ-100 from around 18707 to 18490. But DJ-30 surged around +2.00%, SPX-500 jumped +2.3%, while NQ-100 soared almost +3.0%

Technical trading levels: DJ-30, NQ-100 Future, and Gold

Whatever may be the narrative, technically Dow Future (39824), now has to sustain over 40700 levels for any further rally to 42600  levels in the coming days; otherwise, sustaining below 40650-40450 may again fall to 39250/38700-38200/37950 levels in the coming days.

Similarly, NQ-100 Future (18570) now has to sustain over 18850 levels for any rebound towards 19000/19200-19450/19775 and 20000/20200 in the coming days; otherwise, sustaining below 18800-18700, NQ-100 may gain fall to around 18000/17500-17200/16875 in the coming days.

Also, technically Gold (XAU/USD: 2165) now has to sustain over 2195 for any further rally to 2225/2250-2275/2300; otherwise sustaining below 2190-2145*, may again fall to 2120/2110-2100/2080-2060/2039 and 2020/2010-2000-1995/1985-1975 and even 1940 may be on the card (if Fed indeed goes for direct  QT closing without tapering and delays rate cuts to Sep’24, while a permanent Gaza war ceasefire takes concrete shape).