The Federal Reserve left interest rates unchanged after its latest two-day policy meeting that concluded Wednesday, dashing investor hopes for rate cuts in the near future. The Fed signaled it wants to see more evidence of slowing inflation before considering lowering rates to stimulate the economy.
Fed Sees Progress on Inflation, But Not Enough
The Fed’s benchmark interest rate will remain at 4.75%-5%, the highest level since 2007, as the central bank continues its battle against stubbornly high inflation . Fed Chair Jerome Powell acknowledged recent improvements, with core inflation down to 5.6% in December from 5.9% in September. However, he emphasized the need for more consistent progress before changing policy course.
“We can now say I think for the first time that the disinflationary process has started,” Powell said in a news conference after the release of the Fed statement on Wednesday . “It has a long way to go…but we can see it and can feel it.”
Powell cautioned that a single month’s data provides little evidence that inflation dynamics have changed in a meaningful way. He added that the Fed would need “substantially more evidence” to be confident that inflation is on a long, sustained downward path .
The Fed’s statement removed references to future rate increases but gave no indication of rate cuts anytime soon. Futures traders are currently betting on two quarter-point rate cuts later this year, staring in September .
|Implied Fed Funds Rate
|Chance of 0.25% Cut
Implied futures market expectations for changes in the Fed funds rate. Source: CME FedWatch Tool
Markets Sell Off on Hawkish Fed Statement
U.S. stocks plunged after the latest Fed decision and Powell’s remarks, with the Dow Jones Industrial Average falling over 200 points in afternoon trading . The S&P 500 and Nasdaq Composite also closed sharply lower on the day.
Investors had hoped for a more dovish tone from the Fed that kept rate cuts firmly on the table. However, Powell definitively ruled out any move in March, saying back-to-back monthly inflation reports meeting Fed expectations would likely be needed before a cut .
Long-term bond yields fell on recession concerns related to further Fed tightening. Meanwhile, the U.S. dollar advanced against major currencies as rate cut expectations receded .
“Powell struck a less dovish tone than hoped for, especially around the potential for cuts later this year,” said Commonwealth Bank of Australia currency analyst Joe Capurso .
Gold prices also slumped around 1% as the precious metal grows less attractive relative to yield-bearing assets .
Fed Focused on Anchoring Inflation Expectations
Behind the Fed’s alertness against premature policy loosening lies a desire to firmly anchor inflation expectations. After criticizing financial conditions for being overly optimistic last year, Powell is wary of fueling market hopes that rate cuts could quickly materialize .
Boston Fed President Susan Collins said before the meeting that she wanted to see inflation expectations “solidly anchored” before supporting any rate cuts .
Some Fed officials have cited falling market-based and household inflation expectations measures as justification to move closer towards pausing. However, Powell said inflation expectations remain uncomfortably high and the Fed wants to see them come down further .
The University of Michigan’s January consumer sentiment survey showed declining long-run inflation expectations, though they remained well above pre-pandemic levels. Households expect prices to rise 3.9% annually over the next 5-10 years, down from 4.4% in December but above the 2.9% average during 2017-2019 .
Some analysts say the Fed should be careful not to inadvertently boost inflation expectations again by prematurely suggesting an imminent policy pivot. Kansas City Fed President Esther George said in early February she hadn’t yet seen evidence that inflation dynamics have shifted in a fundamental way .
Path Ahead Depends on Incoming Data
Ultimately, the path of Fed policy will depend on the flow of incoming economic data. Another month or two of declining core inflation could give the Fed confidence to change their tone on rate cuts .
However, risks remain skewed towards higher rates. An adverse surprise on inflation or a blowout monthly jobs report could quickly dampen pivot prospects .
Fed officials will also be monitoring unfolding developments around the world and their potential spillovers to the U.S. economy. These include Europe’s energy crisis, a Chinese reopening still finding its footing, and geopolitical tensions over Taiwan and Ukraine .
For now, investors resigned themselves to a Fed pause lasting at least a few months, with rate cuts unlikely until around mid-year. Markets will hang on every bit of data between now and then for clues pointing to possible cracks in the Fed’s inflation fight.
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