Is the Fed changing its mind on interest rate cuts?

Powell appears to be walking back December optimism on timeline for lower rates

Is the Fed changing its mind on interest rate cuts?

Last week’s interest rate announcement by the Federal Reserve saw the central bank hold its funds rate steady for the fifth consecutive time – and its economic projections, also released on Wednesday, gave an interesting indication of how officials see the rate environment evolving.

Fed officials now expect fewer rate cuts down the line than originally anticipated, with four of 19 officials on the committee indicating that they see rates remaining above 5% in 2024.

That would mean either one or no cuts in 2024, with just one decisionmaker believing rates will tick below 4.5% before the end of the year.

For his part, Fed chair Jerome Powell still expects three rate cuts to arrive in 2024, even if he gave no signal last week of a timeline for rates to start trending lower.

Nonetheless, he continued to sound a hawkish tone on bringing inflation down despite admitting that the funds rate has likely topped out for now.

“We believe that our policy rate is likely at its peak for this type of cycle, and that if the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year,” he said at the post-meeting press conference.

“We are prepared to maintain the current target range for the federal funds rate for longer if appropriate.”

Fed’s changing tone took some market watchers by surprise

Jack BeVier (pictured top), partner at the Dominion Financial Services lender, told Mortgage Professional America that he had been surprised by the Fed’s apparent pivot to a less cautious tone on interest rates at the end of last year, with Powell now appearing to walk back on some of that optimism.

After taking an aggressive stance on rate hikes and the war against inflation throughout 2022 and 2023, Powell caught some observers off guard by stating outright in December that the Fed expected to start cutting rates in the 12 following months.

At the latest "Fed Listens" event, Federal Reserve chair Jerome Powell heard firsthand from business leaders grappling with the challenges of rising interest rates and economic headwinds. #interestrates #inflation #economy

— Mortgage Professional America Magazine (@MPAMagazineUS) March 25, 2024

“I think it’s interesting that there seems to be a real disconnect between what the market believes and what the Fed is now saying. And that is not new,” BeVier said. “It used to be the case that the Fed was very hawkish and the market didn’t think that they had the gumption to actually be as hawkish as they were.

“And then Powell’s reversal in December was really shocking to the market. Of course, the market loved to hear the reversal, and so rates shot down and the stock market shot up. But it seemed premature, because at least by the numbers that we’re paying attention to, it didn’t seem like inflation was yet vanquished.”

Markets increasingly doubtful on prospect of 2024 rate cuts

While the consumer price index (CPI) has been on a downward trajectory since hitting a multi-decade high in the summer of 2022, efforts to restore it to the Fed’s 2% target have proven complicated – with inflation accelerating at a higher-than-expected pace in February, to 3.2%.

That elevated level of inflation remained a key consideration for the Fed in opting to hold its benchmark rate steady last week – and despite Powell’s optimism that lower rates are still in the cards for 2024, BeVier said the markets are increasingly skeptical.

“He’s walking it back a little bit, but he’s still indicating a rate cut this year. But the mortgage markets don’t seem to believe them, because they’ve increased the five-year [rate] and it doesn’t seem to have signs of coming down in the near term.

“So we kind of switched roles – last year, the market was the optimist and the Fed was the pessimist, and then 12 months later the Fed’s the optimist and the market’s the pessimist.”

BeVier said he wouldn’t be surprised if rates didn’t drop at all in 2024, particularly if inflation data continues to trend above a level the Fed is comfortable with.

“I think the data is going to continue to come out a little bit hot, and they’re going to be forced to hold rates where they are currently,” he said. “That may be the whole year, or it may be that we get a December rate cut. That’s my over-under case.”

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