The Fed signals a delay in rate cuts

The Federal Open Market Committee (FOMC or Fed) left the federal funds rate unchanged at its June 12 meeting, but signaled that it is likely to cut interest rates only once in 2024 compared to a projection of three cuts at the March meeting. Markets nevertheless surged on the day because of the release of lower than expected inflation data for May, which may not have been fully reflected in the Fed's projections. Many market participants now expect to see two rate cuts this year.

The pushing back of projected rate cuts between the March and June meetings was driven by higher than expected inflation reports released in the weeks after the March meeting. More recent inflation data have resumed the downward trend that was apparent in late 2023. If the inflation reports for June, July, and August continue to show inflation around the rate reported for May, the Fed is quite likely to cut rates at its September meeting with a possibility of one or two more cuts at the November and December meetings. The Fed is not likely to cut rates at its next meeting on July 31 because it will have only one more month of inflation data. Chair Jerome Powell has indicated that it will take several months of inflation near its 2 percent target before the Fed has the necessary confidence that low inflation is here to stay. In light of the continued strength of the US economy and labor market, the Fed is probably right to take its time before starting to cut rates.

The FOMC also decided to slow the pace at which its balance sheet is shrinking. During the pandemic, the Fed purchased trillions of dollars of long-term Treasury securities and mortgage-backed securities (MBS) to ease credit conditions and support the economy. Since May 2022, the Fed has been allowing maturing securities to run off its balance sheet subject to monthly caps, which rose to as much as $60 billion per month in Treasury securities and $35 billion per month in MBS. The new cap for Treasury securities was lowered to $25 billion per month, and the MBS cap was left unchanged. The Fed's balance sheet peaked at around $9 trillion in mid-2022 and is currently just above $7 trillion. Today's announcement suggests that the balance sheet is likely to stabilize around $6 trillion sometime next year. Even with a stable balance sheet, as maturing long-term securities are replaced by new short-term securities, the average maturity of Fed holdings will continue to decline, contributing to a modest tightening of financial conditions, sometimes referred to as quantitative tightening.