The Federal Reserve’s rate decision on Wednesday came largely in line with investor expectations – no change to the policy rate with only one cut expected in 2024 (down from three), and now four cuts expected in 2025 (up from three). Chair Jerome Powell and other Fed policymakers seem intent on holding a dovish tone, even if the data suggests an economy that does not require any immediate stimulus. Investor sentiment was lifted by May’s inflation readings, which came in lower than expected on Wednesday, reinforcing the belief that rate cuts might occur sooner rather than later. While election season may interfere with the actual timing of cuts, investors remain convinced there will be two cuts in 2024. Equity markets responded by hitting all-time highs following the week’s developments closing the week 1.6% higher. Yields were also sent tumbling on the week, particularly in the belly of the curve, pushing the US Aggregate Bond Index higher by 1.3%.
Interest Rate Outlook: Fed Fund Futures vs FOMC Projections
Federal Funds Interest Rate
Source: Bloomberg, Federal Reserve Board
The Federal Reserve Open Market Committee (FOMC) announced that the central bank would hold Fed Funds rates between 5.25% and 5.50%, and Powell noted at the press conference that the central bank does not yet have the confidence to cut rates, even as inflation has eased from the hotter-than-expected readings from Q1. Powell also suggested that restrictive monetary policy is having the intended effect on inflation, but the central bank is still waiting to see a more sustainable trend toward 2%. Of note, the FOMC updated their economic projections at the most recent meeting and moved the long-term Fed Funds expectations to 2.8%, up from 2.6%. The move higher suggests the central bank sees higher structural inflation and better economic growth, noted in their updated projections.
Cooler Inflation: A Step in the Right Direction for Fed
CPI (MoM %)
Source: Bloomberg, Bureau of Labor Statistics
While the Fed meeting was an important market event, inflation was arguably more critical in shaping the long-term outlook. Consumer inflation (CPI) showed a notable downshift in May with the headline month-over-month figure flat and the core (excluding food and energy) moving higher by 0.2%–lower than expectations of 0.3%. The year-over-year measure printed a 3.3% increase, with the core coming in at 3.4%, both 0.1% lower than consensus. Looking deeper, shelter inflation increased 0.4% on the month and was up 5.4% from a year ago, highlighting a key sticking point amid the Fed’s battle to bring inflation back to the long-term target. Inflation-weary consumers will hope the overall trend continues as prices are more than 20% higher than they were at the end of 2020. Following the report, the stock market posted a strong rally while Treasury yields slid across the curve.
Money Market Assets Hit New-All Time Highs Helped by Higher-for-Longer Expectations
ICI Money Market Balances ($ Millions)
Source: Bloomberg, Investment Company Institute
Following the Fed decision, money-market fund assets rose to a record high on expectations that short-term rates would remain at current levels. $28B was added to money market funds last week, according to ICI data, bringing total assets to $6.12T and surpassing the previous record set in April. Retail investors have piled into money funds since the Fed began one of the most aggressive tightening cycles in decades in 2022, while corporate cash piles continue to grow following economic growth and strong earnings.
– Written by Eric Schmitz, CFA