Time For The Hawks To Come Out And Play
The only real tool the Federal Reserve has at this point to tighten financial conditions in a meaningful enough way to assist their plan to bring inflation back down to target in a timely manner is to use their DOT plot from the SEP in an aggressive manner.
The data thus far in 2024 has been too firm across the board (growth, labor, inflation) to suggest that monetary policy is restrictive enough to get inflation back down to target. Financial conditions across a variety of measurements show how much policy has loosened to levels which today are as accommodative as they were before the rate hiking cycle started in early 2022.
The Fed had the opportunity to use their balance sheet more aggressively to tighten FCI but after the tapering decision last month, they have likely rendered this tool useless for them again (unless they talked more actively about MBS sales which should be happening but seems unlikely).
As a result, the Dot plot is the only tool they have left. Currently, the median dot for 2024 assumes 3 cuts but I think the Fed needs to get aggressive and move this down to no more than 1 cut for 2024. In order to do this, we will need to see at least one dovish member who is at 3 cuts for 2024 move to 1 cut while all the members that are at two cuts also move to 1 cut. I think that if we get a firm CPI print on Wednesday morning, we will get at least one dove to go from 3 cuts to 1 cut.
Truthfully, if the Fed really wants to send a message, we would get several of the doves moving from 3 cuts to 1 cut since they will be upgrading their assessment of inflation and growth for 2024 to levels reasonably higher from where they were to start the year. Obviously, if Powell decides to move to only 1 cut on a firm CPI print, he will likely bring a lot of the more dovish voters with him.
As for 2025, I also think the Fed needs to send a message that a significant rate cutting cycle is not assured. Currently, the Fed is looking for 4 additional rate cuts in 2025 but there are various members who would be looking for less. If the median cut for 2025 goes to only 3 cuts, that would also send a hawkish message and is currently not expected.
The Fed may not like the Dot plot but at this point, they need to use it to communicate. And let’s not forget, they can always change their mind, like they last fall when after “a substantial majority” of members were looking for one more rate hike in 4Q23 at the September SEP, they failed to deliver that rate hike when the data slowed. They could do the same this time around if the data cooperates. But for now, they need to get hawkish to accomplish their mission. If the CPI is on the firm side, I think the Fed will move in this direction.
