May 18, 2024

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Fed sparks market rally as officials stick to plan to cut interest rates

Fed sparks market rally as officials stick to plan to cut interest rates

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Federal Reserve officials have indicated they still expect to cut interest rates by three-quarters of a percentage point this year, sending US stock markets to record levels.

The market's reaction on Wednesday came after the Federal Open Market Committee voted unanimously to keep interest rates unchanged at a 23-year high of 5.25 percent to 5.5 percent.

The central bank also sharply raised its forecast for US economic growth this year, while saying inflation will be slightly higher than expected.

The latest statement leaves the Fed on track to start cutting interest rates as early as the summer, buying time for the task of suppressing inflation that has surged as the U.S. economy emerges from the Covid-19 pandemic.

It also means that borrowing costs and mortgage interest rates, which have risen in recent months, may begin to fall ahead of the presidential election in November.

“The economy is doing well,” Fed Chairman Jay Powell said in the press conference after the FOMC announcement. Officials expect US gross domestic product to grow by 2.1 percent this year, compared to their previous forecast of 1.4 percent.

But with core inflation expected at 2.6 percent this year, slightly higher than expected, Powell signaled that the path to a soft landing could be complicated.

He said inflation was still on a “sometimes bumpy road toward 2 percent,” referring to the Fed's official target. “That's why we approach this question carefully.”

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Concerns about inflation were reflected in the so-called Fed conspiracy. Although it showed that officials believe interest rates will end in 2024 at 4.5 percent to 4.75 percent – the equivalent of three quarter-point cuts – far fewer expect the central bank to risk deeper cuts.

The Fed's policy statement was little changed from its vote in January, although the reference to a slowdown in the labor market was deleted. “Job gains remained strong, and the unemployment rate remained low,” the FOMC said.

The market moves came after the Fed kept three quarter-point cuts on the table for 2024, ignoring warnings from some economists that recent signs of rising inflation could lead to a shift toward just two cuts. The Standard & Poor's 500 index closed up 0.9 percent, hitting a new record high, continuing the rally that pushed the index up 27 percent since October. The Nasdaq Composite rose 1.3 percent.

The two-year Treasury yield, which moves with interest rate expectations, fell 0.09 percentage point to a one-week low of 4.60 percent.

“Today’s chart shows that even though the Fed expects faster near-term growth and slightly hotter inflation, there is no change in interest rate cuts,” said Gargi Chaudhary, head of iShares investment strategy in the Americas at BlackRock. “They still think they need to ease interest rates gradually. I think that's a really great outcome for the markets — for the equity markets and the bond markets. It's a really good outcome for investors.”

As Powell spoke, investors in the futures market added to their bets on a June rate cut, putting the odds at about 85 percent, versus 65 percent on Tuesday.

“The Fed’s conservative approach is justified by incoming data and by financial market participants being aligned with the expected path of interest rates by the Fed,” said Eswar Prasad, professor of economics at Cornell University.

“With no compelling reason to cut interest rates and with inflation still above target leaving little room for a cut, the Fed's negativity on interest rates seems fully justified,” Prasad added.

Along with its more optimistic forecast for economic growth, the Fed said it expects headline and core CPI inflation to reach 2.4 percent and 2.6 percent this year, respectively, while unemployment will rise to 4 percent from 3.9 percent. In December, the Federal Open Market Committee expected headline and core consumer price inflation to reach 2.4 percent for 2024, and expected unemployment to rise to 4.1 percent.

Powell noted that it is too early to know whether recent signs of firmer-than-expected inflation, especially in the services sector, will continue.

“We'll let the data come in. We don't know if this is a bump in the road or something more,” the Fed chief said, adding that he did not believe the latest readings “really changed the overall story” of price pressures falling to 2 percent. .

The Fed also said it will, for now, maintain the pace at which it reduces its holdings of bonds and mortgage-backed securities, a process known as quantitative tightening.

But Powell said the committee's feeling “is that it would be appropriate to slow down the pace of the runoffs fairly soon,” though he added that “that does not mean that our balance sheet will end up shrinking by less than it otherwise would have.” “. “.

Matthew Raskin, head of US interest rates research at Deutsche Bank, said he believed the meeting had taken a generally “dovish” tone, as higher growth and inflation expectations contrasted with officials' expectations of a planned rate cut.

“The striking thing about the statement is how little has changed. There may be little change in the statement as we have seen for a while.”

Additional reporting by Peter Wells in New York