How does the completion of the rotation of the Fed voting committee affect the prospect of interest rate cuts?

In less than two weeks, the Federal Reserve will have its first interest rate meeting of the year.

Traditionally, the Federal Open Market Committee (FOMC), which has the power to make monetary policy decisions, will rotate its members. As the Fed's current tightening cycle draws to a close, combined with the recent volatility of risk assets, investors have turned their attention to the path of future interest rate cuts. Judging from the distribution of the latest internal positions of the committee, the current monetary policy is still a certain distance from turning to substantive easing.

The new FOMC is more neutral

Affected by retirement and other factors, there have been many replacements and reappointments within the Fed since 2023. The FOMC currently consists of 12 members, including Fed Chairman Powell, Vice Chairs Philip Jefferson, Michael Barr, Fed Governors Christopher Waller, Lisa Cook, Adriana Kugler, Michelle Bowman, and New York Fed President John Williams) is a fixed vote, and the remaining four seats are replaced annually by 11 local Fed presidents.

This year's rotation will be Chicago Fed President Austan Goolsbee, Philadelphia Fed President Patrick Harker, Minneapolis Fed President Neel Kashkari and Dallas Fed President Lorie Logan. At the same time, Cleveland President Loretta Mester, Richmond Fed President Thomas Barkin, Atlanta Fed President Raphael Bostic and San Francisco Fed President Mary Daly became new voters.

The first financial reporter sorted out the recent views of the new ticket committee. Hawkish commissioner Mester reiterated the possibility of a rate hike, stressing that the Fed has more work to do. "It's hard to predict the future, it depends on how the economy develops. I think March may be too early. Housing costs and wage growth need to slow to bring inflation more in line with the Fed's 2% target, Mester said.

Other officials are on the sidelines, with San Francisco Fed President Mary Daly speaking on the eve of the silence period saying that the U.S. economy and monetary policy are in good shape, and that risks have become more balanced while inflation reduction is still underway. "We can start to be more patient and look at what needs to be done next. It takes patience as well as graduality. She stressed that unlike last year's focus on fighting inflation, this year's focus is more on the Fed's other task – maximizing employment.

The position of the fixed voters also tends to wait and see. New York Fed President Williams, the Fed's No. 3 figure, said earlier this month that it was premature to call for a rate cut because there was still some way to go to return inflation to its 2% target. The key Powell adviser also said that a restrictive policy stance needs to be maintained for some time to fully achieve the goal. "It is only when we are confident that inflation is continuing to move towards 2% that it is appropriate to reduce the extent of policy restrictions. Williams believes that the economic outlook remains "highly uncertain" and that decisions on monetary policy will be made on a case-by-case basis based on aggregate data, the changing outlook and the balance of risks.

Federal Reserve Governor Waller, the first member of the voting committee to propose an interest rate cut, also "changed his tune" last week. "With economic activity and the labor market in good shape and inflation gradually falling to 2%, I see no reason to act as quickly as in the past. His statement directly hit the market's previous expectations of interest rate cuts.

Boris Schlossberg, macro strategist at BK asset management, said in an interview with Yicai that compared with the start of the interest rate hike cycle in March last year, it is clear that the Fed's internal stance is gradually softening.

He analyzed that judging from the latest distribution of members, the internal forces of the FOMC are shifting to balance, and some of the original hawkish and dove-biased members are gradually leaning towards a neutral position. Schlossberg believes that the Fed may not change its cautious approach until the inflation outlook changes further, which also means that maintaining the status quo in the near term remains the best option.

The outlook for a rate cut is uncertain

Since March 2022, the Fed has raised interest rates by a cumulative 525 basis points. In December, the FOMC opened the door to the possibility of a rate cut.

The market generally believes that at the interest rate meeting held at the end of this month, the Fed kept interest rates stable for the fourth time in a row. However, the real focus will be on the future. Judging by the minutes of the recent meeting itself, there was only preliminary communication within the Fed about cutting interest rates. Some officials have said they are willing to accept interest rate cuts in the first half of 2024 if inflation comes down faster than expected. But officials have given no indication that they plan to use the upcoming meeting to prepare for a rate cut in March.

After recent consumption and employment data show resilience, a policy pivot is not coming anytime soon. Morgan Stanley's chief U.S. economist Ellen Zentner said: "The Fed can be patient. She expects the first rate cut in June. The Fed can take its time because they won't offset the economic contraction by cutting interest rates, as has often happened in the past.

History has also shown the Fed to be cautious when it starts cutting interest rates. In the 70s of the 20th century, central banks eased policy too quickly before inflation was really contained. Volcker, then chairman of the Federal Reserve, made a policy mistake that plunged the United States deeper into recession. Atlanta Fed President Bostic said last week that the worst outcome would be for policymakers to lower interest rates and have to raise rates again at a later date if inflation rises. "We don't want to continue this pattern of going up and down or going back and forth. ”

This week, the US will release an important inflation indicator, the Personal Consumption Expenditures Price Index (PCE), which may have an impact on the policy path. Hu Gang, a partner at WinShore Capital Partners, a New York-based hedge fund, previously said in an interview with Yicai that Fed officials will not show much idea of immediate action for the time being, considering the cost of interest rate cuts and the uncertainty of the future inflation path, "In fact, they are still vigilant now, so I think they are more likely to overturn the current market interest rate cut expectations." ”

Schlossberg told CBN that investors are starting to realize that interest rate cuts are too enthusiastic and need to reprice the path. He believes that the focus should be on the labor market, which will determine the pace and extent of rate cuts, and that it may be more appropriate to start easing at the end of the second or third quarter, with more data to assess the pace of the economic pullback.

He cautioned that the minutes and recent discussions of Fed officials about shrinking their balance sheets mean that this part may be ahead of the interest rate adjustment. With the use of the Overnight Reverse Buyback Mechanism (On RPP) rapidly declining, there is a real reason for scrutiny. This would avoid an unexpected spike in interest rates in the funding market, as was the case in the 2019 repo market turmoil.