FOMC Leaves Fed Funds Rate Unchanged at the May Meeting

The Federal Reserve building.

At this week’s meeting, FOMC members voted to hold the Fed Funds Rate steady for the sixth consecutive meeting. The interest rate decision came as no surprise to business leaders and investors who have been paying attention to the Fed’s recent language and analyst expectations.

The FOMC also voted to slow a targeted portion of the planned balance sheet runoff in the coming months. While both the interest rate and balance sheet decisions were anticipated, these actions – and the data that supports them – still have the potential to impact your business.

FOMC Maintained the Fed Funds Rate at Current Levels

FOMC members voted to hold the Fed Funds Rate steady at a target range of 5.25 – 5.50%. The decision was well-telegraphed by the Fed’s recent language and Chair Powell’s comments last month at the Wilson Center’s Washington Forum on the Canadian Economy. In that public appearance, he noted a “lack of further progress” toward the Fed’s inflation goals and suggested “it’s appropriate to allow restrictive policy further time to work.”

Chair Powell reiterated the sentiment at this week’s post-meeting press conference where he suggested that it will take longer than previously expected for the Fed to attain their inflation goal. His comments during the press conference echoed the meeting statement which said, “the Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”

Inflation, Economic, and Employment Data Support the FOMC’s Decision

FOMC members noted several pieces of data that supported their decision to hold interest rates at the current restrictive level. These include economic expansion, job gains, and elevated inflation.

Economic Activity Continues to Expand

The advance estimate of first quarter GDP released last week by the Bureau of Economic Analysis showed that real GDP grew by an annualized 1.6%. While the move was positive, the growth rate slowed dramatically from the previous quarter’s 3.4%.

The Labor Market Remains Strong

The Bureau of Labor Statistics reported that the unemployment rate was 3.8% in March. This rate has been in a narrow band between 3.7% and 3.9% since August 2023, which is remarkably low by historical standards.

Inflation Remains Elevated

The March Personal Income and Outlays report from the Bureau of Labor Statistics showed that prices for Personal Consumption Expenditures [PCE] rose by 2.7% from one year ago. This is the highest PCE inflation rate since November. Excluding food and energy prices, Core PCE rose by 2.8%. These numbers remain stubbornly above the Fed’s 2% inflation target and the recent rise in PCE shows that inflation is moving in the wrong direction, albeit slowly.

Overall, Chair Powell noted that the current restrictive level of monetary policy is weighing on consumer demand, but lower demand has yet to cause significant disruption in either the labor market or economic activity. Unfortunately, lower demand has also failed to bring inflation down to the 2% target, which necessitates more time with higher interest rates.

The FOMC Will Slow Balance Sheet Runoff

The FOMC also announced that they will continue to reduce the size of the balance sheet by limiting reinvestments into Treasury and Mortgage-Backed Securities. However, they will slow the pace of the runoff for specific securities starting on June 1st.

The monthly cap on Treasury security redemptions will be lowered from $60 billion to $25 billion while the cap on Mortgage-Backed Securities will remain at $35 billion. Chair Powell explained in the press conference following the announcement that a slower pace will help to smooth the transition from quantitative tightening to a stable balance sheet and help avoid stress in money markets. With ballooning US debt, targeting only treasuries could decrease the added stress on the US budget by reducing upward pressure on bond rates without directly impacting the Mortgage-Backed Securities market.

The securities in question were purchased as part of a quantitative easing program to bolster the economy during the pandemic. Then, the FOMC began a quantitative tightening program in June 2022 which seeks to reverse the purchases made during the quantitative easing by limiting reinvestment into the securities. The latest move will slow the pace of the quantitative tightening, signaling that the Fed is nearing the level of securities that they are comfortable holding long-term.

Expectations for Monetary Policy in 2024

Due to persistently high inflation, analysts have adjusted their outlook for interest rate cuts in 2024. Just a month ago, a majority of analysts predicted the first interest rate cut in the current cycle would occur in June with further cuts throughout the year. Now, projections have shifted to September or later and about 20% of analysts don’t expect a rate cut in 2024 at all.

The next FOMC meeting on June 11th and 12th will be accompanied by updated economic projections. This will provide much-needed insight into the Fed’s plans. Until then, businesses can continue to monitor economic developments, paying special attention to inflation, to inform their interest rate expectations.

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