Inside Baseball Version Of the March Fed Meeting

Back in the June and September Dot plots, the Fed was looking for 2024 core PCE of 2.6%. Then, after better inflation momentum in 4q23, they shifted down this projection to 2.4% for the December Dot plot, with a central tendency of 2.4-2.7% (a range 0.1 downshift from September). Also the June and September Dot plots assumed one more rate hike which was never delivered.

After the re-accelerating inflation trends to start the year, I think it’s reasonable to assume that the Fed could shift back higher the core PCE forecast for 2024 back to 2.5 or 2.6% especially given they didn’t deliver that final rate hike last year do policy became less restrictive.

Last June, the Fed was comfortable with a 200bps real rate to end 2024 (4.6%). This jumped to 250bps in September (5.1%) and then back down to 220bps in December (4.6%). Given the positive momentum in economy and inflation to start the year, I think it’s unlikely they would take down this real rate estimate and could probably take it back up again. So we are likely looking at 220-250bps real rate on 2.5% which means 4.7-5.0% (basically the 4.9% line, which is two cuts).

We already know that the Killer B’s (Bowman, Bostic and Barkin; all voters) are in favor of delaying rate cuts this year and Waller’s recent “What’s the Rush?” speech suggests he’s happy to wait as well. Schmid gave a fairly hawkish speech a few weeks ago as well, suggesting he is a 2 cut or less Fed member as well. I think this group of hawks along with the data is going to convince many other Fed members to revise higher their 2024 dot. Given the dynamics in play, I think we are going to see more than 2 members shift their 3 cut expectations up to 2 cuts and probably have some 2 cuts go to no or 1 cuts for 2024. If Powell takes his dot from 3 to 2, he is going to take several members along with him. I also think that the dot that assumes 6 dots this year will come back up as well to help move the mean rate expectation higher as well.

For 2025, in December, the Fed dropped their Dot expectation for YE25 rates to 3.6% from 3.9% while dropping the core PCE from 2.3% to 2.2%. So they went from 160bps real rate to 140bps real rate (this was 120bps at the June meeting). So i think it’s reasonable to believe that the real rate expectation for 2025 can rise as well back to 160bps given data to start the year.

Assuming the 160bps on a 2.2-2.3% core PCE expectation, I think the median dot for 2025 will rise back up to 3.9% again. This means the Fed will be looking for 2 cuts in 2024 and 4 cuts in 2025. While the fixed income markets are increasingly getting to that outcome, I don’t believe equity markets are priced for this scenario.

There has also been plenty of talk from Fed members about the potential that the long term neutral rate has risen. Currently there are 8 dots at 2.5% (median), 3 dots below and 7 dots above (one dot is missing from the LT forecast). I think it’s possible we can see some shift higher in the LT dot as well at this meeting as the range for the LT neutral rate has risen from 2.3-3.6% in March of last year to 2.4-3.8% in December. I think it’s possible we see the neutral rate dot up at 2.6% from 2.5%.

All in all, the Fed has the opportunity here to regain some credibility back from financial markets in its battle to slay inflation. Promoting a more hawkish outlook for the dot plot and the long term dot would help to tighten financial conditions, likely raise term premiums, slow down animal spirits and dampen inflationary expectations.

This is what they “should” do. Whether they will or not is a matter for Wednesday afternoon. If they don’t, risk assets will likely just explode higher until inflation expectations move higher enough to get the Fed to consider getting more hawkish later, when it will be even more difficult to do.

My positioning biases: Long Gold/BTC/Oil, Short Small Caps, Short Duration USTs

Important Disclaimer: This blog is for educational purposes only. I am not a financial advisor and nothing I post is investment advice. The securities I discuss are considered highly risky so do your own due diligence.