Bullish Jay Powell sticks to Fed’s rate-cutting script


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Federal Reserve officials unleashed their optimism on Wednesday, unveiling projections for faster than expected US economic growth this year while still leaving room to cut interest rates three times.

It was a moment of vindication for the Federal Open Market Committee, whose rosy outlook in December had defied more gloomy expectations from economists.

A combination of strong economic growth, low unemployment and falling inflation is historically rare, but Jay Powell’s Fed appears to be pulling it off, all while getting markets in line with officials’ plan for interest rates.

A brisk start to 2024 means officials are now confident that the US economy will expand by 2.1 per cent this year, faster than most other advanced economies and above even their own forecasts three months ago.

While underlying inflation will come in slightly hotter, and the strong jobs market slightly stronger, Powell signalled this would not dissuade the committee from lowering borrowing costs from their current 23-year high of 5.25-5.5 per cent.

“The economy is performing well,” Powell said on Wednesday. Headline inflation of 2.4 per cent was edging towards the Fed’s 2 per cent target, he suggested. “We continue to make good progress on bringing inflation down.”

Markets liked the news — and the Fed’s relaxed mood. The S&P 500 and Nasdaq Composite closed at record highs on Wednesday. Government bond prices rose as yields fell.

Watching from the White House, Biden administration officials would have cheered, too. Borrowing costs appear destined to start falling before November’s presidential election. The soft landing for an economy that many analysts had expected to wilt under the weight of high interest rates is in sight.

Fed rate-setters’ inflation-busting mission looks increasingly likely to end with cuts worth three-quarters of a percentage point this year. While just six officials agreed on three cuts in December, there were nine this time. The projections leave the Fed on track to begin easing monetary policy around June, offering some relief to Americans who have struggled with a surge in mortgage rates and credit card debt costs.

Even so, some economists believe recent US data — notably on inflation — will force the central bank to be more cautious. Academic economists in a recent Financial Times poll said the Fed would cut two or fewer times this year.

Inflation of some goods and services prices remains sticky. Petrol costs, Americans’ most visible gauge of price pressures, have risen 15 per cent since the start of January. Some other costs, such as rents and motor insurance, are still rising quickly.

“I was a little surprised that the Fed’s bias seems to be towards cutting rates even if there’s an improvement in growth,” said Subadra Rajappa, head of US rates strategy at Société Générale. “There was an opportunity at this meeting for the Fed to push back [against a June cut] and they didn’t.”

Instead, a confident and noticeably more relaxed Powell played down a recent uptick in consumer price inflation, from 3.1 per cent in January to 3.2 per cent in February, saying seasonal effects could be behind the increase. Still, the committee would avoid “dismissing data that we don’t like”, he said.

Powell also downplayed the risks that the US’s persistently hot labour market would hinder the inflation fight.

“You saw last year very strong hiring and inflation coming down quickly,” the Fed chair said. “In and of itself, strong jobs growth is not a reason for us to be concerned about inflation.”

The Fed’s big upgrade to forecasts for gross domestic product growth came without any comparable adjustment to its outlook on prices or jobs, defying historical norms in which defeating inflation through higher interest rates has typically led to recessions and steep rises in unemployment.

Yelena Shulyatyeva, senior economist at BNP Paribas, said it showed rate-setters “were really buying into the story” that supply-side factors, including a rise in immigration that has boosted output while keeping a lid on wages, were helping the US economy.

Traders have bowed to the Fed’s logic and rowed back their rate projections from the start of the year, which pointed to cuts of up to 1.5 percentage points by the end of 2024.

But their reaction on Wednesday to the Fed’s announcement was far from disappointment, with a sharp rise in equities feeding a rally that has added 27 per cent to the S&P 500 since October.

“It’s been quite an accomplishment to rein in market enthusiasm from six [or seven] rate cuts to three,” said Vincent Reinhart, chief economist at Mellon.

Some analysts argued that markets had become as optimistic about the US economy as the Fed — and therefore less fixated on the next move in monetary policy.

“The Fed is no longer the most important driver of market trends,” said Tony Welch, chief investment officer at wealth management firm SignatureFD. “Now, it’s improving corporate fundamentals that everyone is watching.”

Mark Dow, author of the Behavioural Macro blog, agreed. “It’s not about Fed liquidity, it’s about risk appetite,” he said, explaining the market’s buoyant mood. “And we can create all the liquidity we need without the Fed.”