This Is What It Sounds Like When Doves Laugh
“It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate on when policy might ease.”
Fed Chairman Jerome Powell spoke those words on December 1 at a fireside chat at Spelman College. The markets rejected that idea and kept pricing in five or six rate cuts next year.
At the conclusion of the final meeting for the year of the Federal Open Market Committee on Wednesday, we learned that Fed officials also do not think it is premature to start speculating on easing.
The Federal Reserve held its benchmark interest rate steady Wednesday, which was what was expected by just about everyone. In the summary of economic projections, which the Fed releases at every other meeting, the median forecast for the federal funds rate fell to 4.6 percent from 5.1 percent at the September meeting.
Bond Yields Crash, Stocks Launch to New Highs
The change in the 2024 forecasts actually understates the loosening of monetary policy. In September, the median fed funds projection for year-end 2023 was 5.6 percent. In other words, Fed officials were still projecting one more rate hike at either the November or December meeting. That hike never happened, so we will enter next year with the equivalent of one cut from where Fed officials projected as late as September.
The September meeting’s projection of 5.1 percent for the end of 2024 implied two cuts from the projected 2023 fed funds rate of 5.6 percent. The latest summary indicates a year-end 2024 rate that is a full percentage point—the equivalent of four quarter point cuts—below the older projection.
While few expected the Fed to brandish a hawkish view of interest rates in the summary of economic projections, the dovishness of views of Fed officials did come as a shock. The yield on the 10-year Treasury, which had already fallen by 80 basis points since mid-October, plunged further following the announcement and release of the projections. An hour after the release, the yield on the 10-year was threatening to break below four percent.
The Dow Jones Industrial Average rose by more than 400 points to cross 37,000 for the first time.
We said yesterday that we doubted Powell was going to play the Grinch at his press conference this week. We did not expect the Fed to decide to play interest rate Santa Claus.
The Fed Expects Less Inflation…and Less Disinflation
The market read the projections and Powell’s press conference as an endorsement of its view that the Fed will cut rates early and often next year. The odds of a cut in March jumped to around 75 percent, up from 60 percent or so prior to the meeting, according to the CME fedwatch tool. The odds that the Fed will cut rates all the way down to a range of 3.50 percent to 3.75 percent—seven cuts from where we are now—rose from close to zero to 25 percent.
Interestingly, the view of Fed officials of inflation going forward has changed by a lot less than their views of interest rates. The median projection for the personal consumption expenditure price index is an increase of 2.4 percent in 2024, just one-tenth of a point below the 2.5 percent projected at the September meeting. The following year, inflation is seen as running at 2.1 percent, also just a tenth of a point lower than the September projection.
The Fed is much more optimistic about this year’s inflation. It sees inflation this year coming in at 2.8 percent, which is a half a percentage point lower than the September projection. The projection for core PCE inflation dropped by the same amount, from 3.7 percent to 3.2 percent.
If we put these together, they indicate that the Fed officials believed in September that inflation would fall by 80 basis points next year, from 3.3 percent to 2.5 percent. Core inflation was seen as falling 110 basis points, from 3.7 percent to 2.6 percent.
Trader Greg Rowe works on the floor of the New York Stock Exchange on December 13, 2023, in New York City. (Michael M. Santiago/Getty Images)
Now the Fed sees less disinflation. Headline PCE inflation is projected to fall at half the rate, 40 basis points. Core is projected to decline 60 basis points.
There’s at least an internal consistency here. The Fed is projecting what might be thought of as twice as many cuts (if we include the foregone hike as a cut) and half as much disinflation.
The market’s reaction to this is clear: put out the milk and cookies. Santa Claus is coming to town, and he’s carrying a sack full of rate cuts.
