January FOMC meeting

The main points of the FOMC statement and accompanying press conference may be summarised as:

• The key phrase from the FOMC statement was: “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.”
• Chair Powell acknowledged that the labour market is in better balance but remains strong, which is supporting growth.
• Growth surprised to the upside last year despite policy being restrictive. The Fed still expects activity to slow this year and there remains considerable uncertainty regarding the future of the US economy. 
• Good progress has been made on inflation so far particularly over the past six months but the Fed needs to see more evidence of it moving to and staying at target. 
• The Fed expects to cut rates at some point this year but there was a strong pushback against the likelihood of that happening in March. 
• There was a strong emphasis on data dependency, something that Powell repeated several times during the press conference. 
• Price stability is incredibly important, especially for people at the lower end of the income spectrum. So that remains the Fed’s focus at the moment.
• Questions are starting to arise at the Fed about the pace with which the balance sheet is contracting. Balance sheet normalisation and interest rates are two independent policy tools. One does not necessarily influence the other. 

Chart 1. PCE deflators (6m % annualised)

Source: Bureau of Economic Analysis and EFGAM calculations. Data as at 26 January 2024.

In summary, the Fed delivered a reasonable response to the decline in inflation seen over the second half of 2023. However, the Fed wants to be absolutely certain that those trends are firmly in place before implementing rate cuts, which they expect to do at some point this year. The key message is to keep on watching the data. The more the data points to a sustainable decline in inflation towards target, the greater the likelihood that the Fed will cut. It is worth noting that if current price pressures - as captured by the 6-month inflation rate - continue, 12-month inflation will continue to move closer to target over the coming months. Against this background, the market reaction seems overdone and perhaps the FOMC meeting was used as an excuse for some profit taking rather than the true reason for it. There are two offsetting points to remember in this context. First, that in the battle between growth and inflation it is always better for risky assets if growth is stronger. Secondly, risks remain to the US economy and we should not forget that hard landings always start out looking like soft landings, something of which the Fed is no doubt acutely aware.