2023 The Last FOMC Ends How the Fed's rate cut action next year will affect the market

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Wall Street Journal: Three rate cuts in 2024

https://www.wsj.com/economy/central-banking/fed-holds-rates-steady-and-sees-cuts-next-year-4d554e9f

The Fed kept interest rates unchanged and said inflation was improving faster than expected, leaving the door open for a rate cut next year. Most officials expect three rate cuts in 2024 in their forecasts released after Wednesday's two-day meeting.

Officials have been reluctant to declare mission complete and have been careful not to rule out a rate hike in their policy statement, which is little changed from the recent version, which has already said that tighter policy is still possible. But with inflation falling much faster than officials expected this year, another rate hike seems out of reach. In their latest forecasts, officials expect core prices excluding volatile food and energy items to rise 3.2 percent year-on-year in the quarter, down from 3.7 percent forecast in September. They expect core inflation to end next year at 2.4%, down from 2.6% in September.

In Wednesday's decision, the Fed has now left its benchmark federal funds rate unchanged at three consecutive policy meetings. Since raising rates from near zero in March 2022, they recently raised rates to between 5.25% and 5.5% in July, the highest level in 22 years.

Most Fed officials are reluctant to publicly discuss when rate cuts will begin, but investors in the interest rate futures market expect them to start cutting rates next spring and cut the federal funds rate by at least 1 percentage point by the end of 2024.

In September, officials predicted one more rate hike this year, followed by two cuts next year, bringing the federal funds rate down to about 5.1%. On Wednesday, officials predicted that they would cut interest rates to about 4.6% by the end of 2024, equivalent to three quarter-point rate cuts.

Central bankers are trying to balance two risks: one is that they move too slowly to ease policy, leading to the economy eventually collapsing under the weight of higher interest rates, leaving millions of people unemployed. The other is that they loosened policy too soon, with inflation stabilizing above 3% – above their 2% target.

The outlook for the U.S. economy has improved in recent months due to slowing inflation and wage growth. If the economy is weaker than officials expect, this will give the Fed more room to cut rates quickly, and even if the expansion does not stall, it could leave the door open for rate cuts.

Government data released on Wednesday showed a very modest increase in core prices, excluding food and energy items, in November, as measured by the Fed's preferred inflation gauge, to be released later this month. This could bring six-month annualized inflation to or slightly below the Fed's 2% target.

At the same time, the labor market is cooling but remains solid. The unemployment rate fell to 3.7% last month from 3.9% in October, and private sector employers added an average of 130,000 jobs per month over the past six months, down from 228,000 in the previous six months.

A year ago, many economists expected that Fed officials would have to raise interest rates enough to create enough room for loosening (such as unemployed workers and idle factories) to significantly slow inflation. But the repair of supply chains and the influx of labor markets are dampening wage and price increases without leading to broad-based economic weakness.

The reasons why officials lowered interest rates are important. Typically, central banks cut interest rates to support the deterioration of the economy and the job market. In fact, this forms the basis of next year's reduction projections.

But Fed officials have admitted that they are likely to lower interest rates next year, simply because inflation is rapidly approaching their 2% target. As inflation falls, keeping interest rates steady leads to an increase in inflation-adjusted or "real" interest rates, which the Fed does not want. Officials are likely to lower nominal interest rates simply to prevent real interest rates from becoming too tight.

Fed Governor Christopher Waller's comments last month added to optimism about that possibility, saying that the central bank could theoretically start lowering interest rates in the spring if inflation is performing exceptionally well.

"If we see this [lower] inflation going on for a couple of months — I don't know if it could be three, four, five months?—— we might be confident that inflation is really coming down," Waller said. ”

However, officials don't want to declare victory on inflation yet, nor do they want to trigger a market rally that will make it more difficult for them to sustain the slower economic growth they see as necessary to conquer inflation.

Bloomberg: The rate cut has exceeded economists' expectations

https://www.bloomberg.com/news/live-blog/2023-12-13/fomc-rate-decision-and-fed-chair-news-conference

Here are the five main takeaways from Wednesday's Federal Open Market Committee (FOMC) interest rate decision and Fed Chair Jerome Powell's press conference:

1. The Federal Reserve kept interest rates steady at its third consecutive meeting and sent the clearest signal to the market that its aggressive rate hike campaign was over by forecasting three quarter-point rate cuts next year, which exceeded economists' expectations. Based on the median projections of 19 officials, policymakers expect the federal funds rate to fall further to 3.6% by the end of 2025. The market reacted broadly to the committee's moderate tone.

2. Powell said that the committee discussed a rate cut at this week's meeting, but did not rule out the possibility of another rate hike if the data calls for it. Even so, the statement reinforces the feeling of turning dovish. The FOMC softened its tone on its stance on further rate hikes, adding a phrase to the statement that officials would consider the extent necessary for "any" additional policy tightening.

3. Despite Wednesday's unanimous vote, the Committee was clearly divided on its interest rate outlook. Eight officials expect fewer than three quarter-point rate cuts next year, while five expect more. Powell welcomed the reduction in inflation forecasts from last quarter's forecast, while warning that the battle is not over. Some FOMC participants adjusted their forecasts based on this week's inflation data.

4. The Committee is seeking a soft landing for the U.S. economy rather than a recession, and expects the unemployment rate to rise only slightly in the coming years. Powell said that the labor market is becoming better balanced and wage growth has slowed, although they are still slightly above levels consistent with 2% inflation. Given the progress made, Powell said the two Fed mandates – full employment and price stability – are equally important now.

5. Markets have embraced the more dovish tone of the FOMC and Powell and are now anticipating the first rate cut in March. S&P 500 gains extended to 1%. The two-year Treasury yield fell 25 basis points to about 4.5%. The US dollar is heading for its lowest level since August. Swap contracts are repriced, in line with the 130bp easing level over the next 12 months.

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