What was of more interest was the accompanying Summary of Economic Projections (SEP) document, including the famous dot plots. While growth projections were unchanged, the Fed revised higher its outlook for inflation this year, from 2.6% in March to 2.8% at the latest meeting. Furthermore, the dot plots shifted higher. Whereas in March the median Federal Open Market Committee (FOMC) member expected the Fed to cut the fed funds rate three times this year, the median FOMC member now expects to cut only once this year. Moreover, the long run median estimate of the fed funds rate also shifted slightly higher, from 2.6% to 2.75%. This represents a more hawkish outlook relative to the March meeting but is noticeably less hawkish than the dot plots from December and September last year.
Investment Insights • MFN
3 min read
The Fed, inflation and the dot plots
As was widely expected, the Federal Reserve remained on hold at its meeting on 12 June. The accompanying statement was little changed from the prior meeting.
Chart 1. Fed dot plots and market rate expectations
Source: Federal Reserve and EFG calculations. Data as at 13 June 2024.
It was no doubt a relief for the FOMC that the consumer price index (CPI) inflation data that were also released on 12 June showed an improvement. Indeed, Chair Powell hinted at that in the post-meeting press conference. Moreover, it was encouraging that various CPI sub-components pointed to better inflation dynamics. For example, the super-core measure (core services inflation ex-housing) was close to 0% over the month of May and declined year-on-year (YoY). At the same time, the YoY% change in goods prices fell further into deflation and the housing component also showed further evidence of slowing inflation on a YoY% basis, albeit at an elevated level. Whilst some comfort can be taken from the CPI release, one data point does not make a trend. The Fed will need to see several months’ data going in the right direction before concluding that inflation is “moving sustainably towards 2 percent”.
Chart 2. CPI inflation (YoY%)
Source: Bureau of Labor Statistics and EFG calculations. Data as at 13 June 2024.
At the same time, the labour market remains tight, as evidenced by last week’s non-farm payroll data and persistently low weekly initial jobless claims. This too supports the Fed’s case to wait for more data.
If we see consistently better-than-expected inflation data over the next couple of months that would likely be sufficient for the Fed to cut rates at their meeting on 18 September. However, if inflation continues to decline only slowly or the data is inconclusive then expectations may need to be pushed out further regarding the timing of the Fed’s first rate cut in this cycle. Fixed income markets and rate expectations are likely to remain volatile in response to incoming data and its perceived impact on the timing of any changes in Fed policy.
A related comment applies to the dot plots, with the market focusing on the median measure. Whilst this provides a convenient summary of the Fed’s views, it ignores how the distribution of views changes over time. It is notable that in March this year only one FOMC member was more dovish than the median in terms of their rate expectation for 2024. It only required one individual to increase their rate outlook for the median to move higher.1 And in practice 10 FOMC members increased their expected rate path for 2024. Given stronger-than-expected inflation and labour market data for much of the year-to-date, the bar was quite low for this to happen.
It is worth noting that the risk to the Fed is asymmetric. If they cut too early they risk stoking inflation and losing credibility, making their job harder in the future. If they are overly restrictive, they risk a weaker economic environment but they solidify their inflation fighting credentials. Furthermore, they always have the option of cutting quickly and aggressively if necessary, potentially in an unscheduled meeting. It is easier for the Fed to correct for being too hawkish than to make amends for being too dovish.
Similarly, the Fed has little incentive to talk more dovishly unless they have a very high degree of confidence that inflation is heading sustainably towards target. If they are dovish in their communications then they risk market financial conditions easing in anticipation of looser policy, something that could also stoke inflation even if the policy rate is unchanged.
In summary:
- The Fed was on hold, as expected.
- The dot plots moved higher, as expected.
- At this potential inflection point in policy, it is natural for there to be greater-than-normal uncertainty regarding Fed policy, something that implies the Fed will be highly sensitive to incoming data.
- The latest CPI print was encouraging but will need to be ratified by incoming data over coming months before the Fed will be comfortable cutting rates.
- Fixed income markets are likely to stay volatile in the meantime.
1 This is because the March dot plots showed that nine FOMC members shared the same view as the median.