ContactMay FOMC: The Balance Sheet is All We Get
May 02, 2024
Executive Summary:
- The Federal Open Market Committee (FOMC) decided to slow the pace of balance sheet runoff at the May meeting, while offering little guidance on the path forward for interest rates.
- It was a coin flip going into the meeting whether they would slow quantitative tightening (QT) at the May or June meeting, and the announcement does not affect our market outlook.
- The Committee acknowledged the lack of further progress on disinflation in the 1st quarter, but otherwise left their assessment of the economy and risks to the outlook little changed.
- With the meeting over, our Federal Reserve (Fed) view remains the same. Assuming growth remains stable, the earliest meeting for a cut is September, but it seems unlikely that they gain enough confidence to cut before December.
The May FOMC meeting felt like a placeholder. The Committee added the line “[that] in recent months, there has been a lack of further progress toward the Committee’s 2 percent inflation objective” to the policy statement. However, Chair Powell previewed this change in his last public appearance before the meeting. The next change adjusted the Committee’s view on the balance of risks to put progress in the past tense, a logical extension of the previous change. Finally, they decided to taper the pace of QT beginning in June.
The decision was telegraphed in the March meeting minutes, but it was a toss-up whether the announcement would come at the May or June meeting. The Committee lowered the monthly cap on Treasury redemptions from $60 billion to $25 billion, lower than the $30 billion investors anticipated. Unlike the last time the FOMC tapered QT in 2019, the Committee did not provide any information on when they anticipate the passive runoff to cease. The Committee onboarded the lesson from the spike in repo rates in 2019 about the difficulties inherent in forecasting banks’ demand for reserves and that providing calendar-based guidance on the balance sheet offered few benefits. The balance sheet decision likely explains the fleeting decline in Treasury yields after the statement as slower QT means less Treasury issuance in the near-term. However, we do not anticipate any meaningful impact on the outlook from the change in balance sheet policy.
During the press conference, Chair Powell said that “it’s unlikely that the next policy rate move will be a hike.” Rates and equity markets responded positively to the remark, but the effect faded by the close of the U.S. market. Stepping back, Chair Powell and the Committee will view the limited reaction in markets as a great outcome. The incremental data since the March meeting confirmed that progress on disinflation stalled and growth remained strong in Q1, which led markets to reduce the number of cuts this year to around one. Today’s meeting affirmed that shift and all of us are left waiting “to see further progress on inflation this year.”
Looking at the calendar, we have the following number of inflation prints ahead of each meeting: 2 for June, 3 for July, 5 for September, and 8 for December. Our assumption is that the Committee has a strong preference to announce large policy shifts at SEP meetings, i.e. March, June, September, or December, and that November is a no go given it coincides with the election. It seems unlikely that the Committee will have enough confidence by the September meeting, absent a growth scare, making the December meeting and one cut the most likely outcome for the Fed this year. In our view, the risk reward of leaning against inflation concerns is becoming more attractive than leaning into them at this point. The open question for us is whether that will benefit equities disproportionately given valuations do not scream cheap as strong growth and the inflation-protection embedded in their nominal cashflows has kept risk premia low.
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Important Information
The views expressed herein are those of Harbor Capital Advisors, Inc. investment professionals at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice. The information provided in this presentation is for informational purposes only.
This material does not constitute investment advice and should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy.
Investing entails risks and there can be no assurance that any investment will achieve profits or avoid incurring losses.
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