Central bank update: Fed on hold, but more volatility to come?

Since the last US Federal Reserve (Fed) meeting in March, US data has remained stubbornly resilient, particularly when it comes to inflation data; US Consumer Price Index (CPI) has beaten consensus expectations for the last three months in a row, while other measures such as the Personal Consumption Expenditure (PCE) Core Deflator – which the Fed pays particular attention to – came in higher than the level consistent with the Fed’s objective of 2.0% inflation over the medium term.

On top of this the labour market remains buoyant and wages data (such as the Employee Cost Index – another Fed favourite) came in above expectations. Having pledged to be led by the data, and with dual mandate covering inflation and growth, the Fed was faced with a potentially tricky challenge at its May meeting, having previously given a signal that the next move in interest rates would likely be a cut. The market had already pushed back pricing of the first cut towards the end of 2024, having, at one point, priced as many as five cuts this calendar year.  

Going into this meeting, there was even some speculation that the next move from the Fed could potentially be a rate hike. All eyes were focused not so much on the rate decision itself, but on the wording accompanying the policy announcement and the comments in the press conference following the statement. Any hint of a hawkish pivot would likely be seized upon by the market as a signal for US treasuries to sell off (likely dragging other global bond markets with them), yield curves to flatten further and pressure being placed on other central banks to re-assess their plans for monetary policy changes at least in the short term.

In the event, as expected, the Fed chose to keep the target Fed Funds rate on hold at 5.50% for sixth consecutive time and whilst Powell did acknowledge “a lack of further progress toward the Committee’s 2.0% inflation objective”, the messaging was very much skewed towards the decision being as to how much longer to hold rates at the current level before cutting, rather than any rate hikes. He said that if inflation proves more persistent than expected, then “it could be appropriate to hold off on rate cuts”. He also pointed to the fact that they were not solely looking at incoming inflation data and stated that a rate cut could be in response to an “unexpected weakening in the labour market”.

The statement also confirmed a scaling back in the Fed’s balance sheet reduction program (QT), starting in June 2024 where they would reduce monthly sales of treasuries back to the market from $60bn to $25bn. Whilst Powell pushed back on the idea of this being an easing of policy – interest rates are the active tool of monetary policy – the market seemed to interpret this a little differently with short end US treasury yields falling by up to 10 basis points following the announcement. Having feared the possibility of a ‘hawkish pivot’ from the Fed, the market took relief from the messaging of potentially ‘higher for longer’, rather than ‘higher still’. In addition to this, the explicit mention of a weakening in the labour market being a possible reason to ease policy, gave the market a reason to rally further. However, what this does mean is that even more weight is going to be placed by the market on US employment data, and with the latest Non-Farm Payrolls data due on 2 May, we can reasonably expect even more volatility as market participants try to second-guess the Fed’s reaction function.

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