The Fed plans to cut rates, but not yet in March

At yesterday's meeting, the Federal Reserve left its interest rate target range unchanged. In a statement after the meeting, the central bank removed the reference to possible further increases. But before the first cut occurs, the Fed wants to be sure that inflation has truly been defeated. Powell suggested that a March move down is unlikely at this point. As a result of these words the dollar appreciated, the yields of American bonds increased and the valuation of indices decreased.

As expected, the Fed left its key interest rates unchanged. The target range for the federal funds rate is still at 5,25%. – 5,50 percent

Positive inflation data

The Fed currently assesses that the risks to achieving its inflation and employment targets are now better balanced. Risk of excessive inflation is no longer as dominant as in recent years. The previous attitude towards potential further increases also disappeared from the statement. Now the Federal Reserve is explicitly addressing the terms of interest rate cuts. Here the condition indicated is permanent decline in inflation and approximation to the level of 2%.. The topic of QT was treated superficially. The bank will continue to reduce its securities portfolio at an unchanged pace, i.e. to USD 80 billion per month). A larger discussion on reducing the balance sheet is expected to take place in March.

During the conference, Powell noted that recent inflation data were positive. He emphasized that in the six months to December, both total and core inflation were at or slightly below 2%. on an annual basis. It is clear that the Federal Reserve is becoming more and more confident that the fight against inflation is being successful. This confidence may be strengthened or weakened by inflation readings from the first quarter of this year. I have the impression that the market will be even stronger now focused on CPI and PCE readings and market volatility will be greater in the event of any surprises.

Powell also addressed the labor market and economic data. He made it clear that the Fed does not want to weaken the economy and does not want to see a weaker labor market. A change in rhetoric is visible here, as during previous meetings the institution assumed that the economy would have to cool down significantly to combat high inflation. Now, however, the price growth dynamics has decreased and the economy is still operating at a decent level.

Excessive market expectations

The dollar eventually strengthened. The EUR/USD rate dropped to 1,0800 and this morning the declines are deepening and the quotations indicate 1,0785. The short-term downtrend in the major currency pair therefore continues. Wall Street ended the day in the red. On the graph Dow Jones showing daily data, a bear market engulfing pattern is visible. The pattern drawn within historical records predicts an imminent correction.

The market valuation of the probability of a March cut has decreased and currently oscillates around 36%. The May downward move is still considered a highly realistic start of the cycle of easing monetary conditions. The Fed is still planning cuts in 2024, nothing has changed here. However, the market must once again adjust its excessive expectations.

Source: Łukasz Zembik, OANDA TMS Brokers