The Federal Reserve left interest rates unchanged at the conclusion of its two-day policy meeting on Wednesday, but strongly signaled it could cut rates in the coming months if the economy slows further.
Key Takeaways
- The Fed kept its benchmark federal funds rate steady in a range between 4.25% and 4.5% after raising rates seven times in 2022 and 2023 to fight high inflation.
- Policymakers removed language from their statement saying they expect “ongoing increases” in rates, opening the door to possible cuts.
- Fed Chair Jerome Powell said in his press conference that the case for rate cuts has strengthened amid slowing global growth, easing inflationary pressures, and turbulence in financial markets.
- The Fed lowered its GDP growth projections for 2023 to 1.9% from 2.0% in December. It also reduced its inflation forecast.
- Markets are now pricing in two 0.25 percentage point rate cuts by the end of 2023, with the first cut likely coming as early as March.
Fed Drops Language Pointing to More Rate Hikes
In their post-meeting statement, Fed policymakers removed key language from December that said “ongoing increases in the target range will be appropriate.” This signals an openness to pausing or reversing their aggressive rate hiking campaign that began in early 2022.
The Fed noted that recent indicators point to modest growth in spending and production. Policymakers also said inflation has eased somewhat but remains elevated. This suggests they see progress in disinflation but not enough to declare victory yet.
Powell: Case for Rate Cuts Has Strengthened
In his closely-watched press conference, Powell said the disinflationary process has started but it has a long way to go. He expects 2023 to be a year of “significant declines in inflation.”
Powell stated that the easing in financial conditions recently has counterbalanced the Fed’s tightening over the past year. This implies markets are doing some of the tightening work for them.
The Fed Chair bluntly admitted the central bank overtightened policy last year. However, he declined to say if rates are now appropriately calibrated to the economic outlook.
Powell noted the lagged effects of the Fed’s restrictive policy are still to be felt. But he said if the economy slows more than expected, the case for rate cuts “has increased.” Markets viewed this as a strong signal that cuts are on the way, perhaps in the next few meetings.
Fed Lowers Growth and Inflation Projections
The Fed’s updated Summary of Economic Projections showed lower median forecasts for GDP growth, unemployment, and inflation this year:
| Metric | 2023 Projection | Change from December |
|---|---|---|
| GDP Growth | 1.9% | Down from 2.0% |
| Unemployment Rate | 4.6% | Unchanged |
| PCE Inflation | 3.5% | Down from 3.6% |
The lower growth and inflation projections reflect policymakers’ more cautious view of the economy. But the fact that they kept their unemployment rate outlook steady suggests Fed officials are hoping for a soft landing rather than a severe downturn.
Powell emphasized in his press conference that their base case is for continued economic expansion and strong labor market conditions. However, risks are to the downside, necessitating possibly lower rates.
When Could the Fed Cut Rates?
Based on interest rate futures pricing, markets believe there is an 85% chance of at least one 0.25 percentage point rate cut by July. About two cuts are expected by year-end.
The timing of the initial cut is data-dependent. But several economists predict cuts could come as early as the next FOMC meeting on March 20-21 or at the subsequent May 2-3 meeting. Key data points to watch will be each monthly jobs report and inflation reading leading up to those meetings.
Former St. Louis Fed President James Bullard said on January 24 he sees rate cuts possible starting from March onward. Bullard is known for making provocative rate predictions that later match the Fed’s moves.
Other Fed officials in recent weeks have similarly discussed rate cuts in the second half of 2023 if growth slows and disinflation continues. The tone seems to be shifting towards easing starting mid-year.
Global Slowdown, Market Turmoil Concerning Fed
Behind the Fed’s dovish turn are worrying signs of slowing global economic activity alongside recent financial market volatility.
Powell said the global slowdown raises risks for the U.S. economy this year through weaker trade flows and commodity prices. Resurgent COVID-19 infections in China add uncertainty.
Meanwhile, a rout across risk asset markets so far in 2023 including stocks, corporate bonds, and cryptocurrencies also caught the Fed’s attention. Tighter financial conditions could dampen investment and consumer spending.
The Fed does not set policy to directly support asset prices. But extreme financial turbulence that threatens to slow the real economy can nudge them towards cutting rates.
Powell dismissed that the Fed was bending to political or market pressure for rate cuts. But he made clear they are closely monitoring global developments and markets in assessing the appropriate policy path.
Outlook: More Data Needed Before Committing to Cuts
The January FOMC meeting officially opened the door to coming Fed rate cuts after last year’s aggressive tightening campaign. Markets foresee easing likely beginning around mid-2023 depending on how key economic data and global events evolve.
However, Powell stressed additional information will guide their decisions meeting-by-meeting before committing to actual cuts. The Fed needs convincing evidence of a meaningful slowdown in economic activity and disinflation progress to justify reversing course on rates within the next few meetings.
Markets will hang on every piece of economic data between now and March or May searching for clues on whether the threshold has been met for cuts. Powell maintains rates could still rise further if the economy remains resilient. But most analysts now view rate cuts before 2023 ends as highly probable amid a cloudy global outlook.
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