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Recent News
Sitting tight… The Federal Open Market Committee (FOMC) will almost certainly leave its interest rate target range unchanged at this week’s meeting. The CME Group puts the odds of a rate cut at a mere 3.1 percent.
The FOMC has held its federal funds rate target range at 5.25 to 5.5 percent since July 2023. But it intends to start cutting rates this year. In December 2023, the median FOMC member projected the federal funds rate would decline 75 basis points this year.
When will the FOMC start cutting rates? Markets are currently pricing in a 48.1 percent chance that the federal funds rate target will be lower in March and a 65.6 percent chance it will be lower in May. Expect these odds to move a lot on Wednesday if Federal Reserve Chair Jerome Powell provides better forward guidance.
Trust the (disinflation) process… Inflation slowed significantly over the last year, the latest data from the Bureau of Economic Analysis shows. The Personal Consumption Expenditures Price Index (PCEPI) grew at an annualized rate of 4.2 percent in Q1-2023, 2.5 percent in Q2, 2.6 percent in Q3, and 1.7 percent in Q4. In December 2023, the PCEPI grew at an annualized rate of 2.0 percent.
Core inflation, which excludes volatile food and energy prices and is thought to be a better predictor of future inflation, has also declined. Core PCEPI grew at an annualized rate of 5.0 percent in Q1-2023, 3.7 percent in Q2, 2.0 percent in Q3, and 2.0 percent in Q4. Core PCEPI grew at an annualized rate of 2.1 percent in December.
FOMC members were late to recognize rising inflation in 2021 and slow to begin tightening in 2022. They eventually tightened monetary policy, though, which brought inflation back down. Indeed, inflation has fallen more quickly than most FOMC members anticipated. In December, the median FOMC member projected the PCEPI would grow 2.4 percent in 2024. Inflation projections will almost certainly be revised down in March, when FOMC members submit new projections.
Excessively restrictive… Although low inflation is a welcome change from the economic situation of a year ago, it also means that real (inflation-adjusted) rates have risen higher than anticipated. Consider the FOMC’s federal funds rate target range. With inflation at 2.0 percent, the real target range was 3.25 to 3.5 percent in December.
For comparison, the New York Fed estimates the natural rate of interest—that is, the rate at which monetary policy would be neutral—at 0.88 percent (Holston-Laubach-Williams) and 1.9 percent (Laubach-Williams) for Q3-2023. The Richmond Fed estimates the natural rate at 2.17 percent (Lubik-Matthes). Hence, the lower bound of the real federal funds rate target range was 1.08 to 2.37 percentage points above conventional estimates of the natural rate. That suggests monetary policy is very, very tight at present.
Production… Real Gross Domestic Product (GDP) grew at an annualized rate of 3.3 percent in Q4-2023, according to the latest release from the Bureau of Economic Analysis. It grew 4.9 percent in Q3.
Despite strong growth over the last six months, real GDP remains below its pre-pandemic growth path. The Atlanta Fed’s GDPNow model is currently forecasting 3.0 percent real GDP growth for Q1-2024. That would help reduce the gap.