In a pivotal move, the Federal Reserve announced on December 13, 2023, its decision to maintain its key interest rate unchanged, marking the third consecutive time this has occurred. This decision sets the stage for a series of potential rate cuts in 2024 and beyond, signaling a significant shift in monetary policy.
Currently, the Federal Reserve's benchmark overnight borrowing rate holds steady within a range of 5.25% to 5.5%. This decision, unanimously agreed upon by the Federal Open Market Committee (FOMC), comes amidst a backdrop of easing inflation and a stable economy. The committee has also outlined plans for at least three rate reductions in 2024, each by a quarter percentage point. This forecast is slightly less than what the market had anticipated (four cuts) but represents a more aggressive stance compared to previous indications from the officials.
The decision to maintain the current rate ends a cycle of 11 hikes, which elevated the fed funds rate to its highest level in over two decades. Despite uncertainties about the FOMC's approach to policy easing, the Dow Jones Industrial Average responded positively, rising more than 400 points and surpassing 37,000 for the first time following the announcement.
Looking further ahead, the committee's projections, often referred to as the "dot plot," indicate a possibility of four additional cuts in 2025, amounting to a full percentage point. Projections for 2026 suggest three more reductions, potentially bringing the fed funds rate down to between 2% and 2.25%, aligning closely with the long-term outlook. However, there is notable variation in these estimates for the final two years.
Contrary to the FOMC’s projections, the market reacted by pricing in a more aggressive rate-cut path. Expectations have now risen to 1.5 percentage points in reductions for the following year, doubling the pace indicated by the FOMC.
The Fed's recent statement hinted that the cycle of rate hikes might be concluding. It emphasized that multiple factors would be considered for "any" further policy tightening, a term that was newly introduced. Rick Rieder, the chief investment officer of global fixed income at BlackRock, interpreted this as a sign of potential easing of the previously high interest rates in the coming months.
In addition to interest rate adjustments, the Fed has been allowing up to $95 billion a month in proceeds from maturing bonds to roll off its balance sheet, a process that has continued without indication of curtailment.
The backdrop for these decisions is an improving inflation scenario. Inflation has receded from its 40-year peak in mid-2022, a development that has occurred without a significant rise in unemployment. Federal Reserve Chair Jerome Powell, in a news conference, remarked on the easing of inflation over the past year, although prices remain elevated. The Fed officials project core inflation to decrease to 3.2% in 2023 and further to 2.4% in 2024, ultimately aiming to reach the 2% target by 2026.
Recent economic data reinforces this trend, with both consumer and wholesale prices showing minimal changes in November. Some calculations, such as those from Bank of America, suggest that the Fed's preferred inflation gauge might be aligning closer to its 2% target on an annualized basis.
The Fed's statement also reflected a change in economic activity assessment, shifting from "expanded at a strong pace" in November to "has slowed." During the press conference, Chair Powell elaborated on this, indicating a substantial slowdown in economic activity growth compared to the rapid pace observed in the third quarter. Nonetheless, he projected a 2.5% expansion in GDP for the year.
The FOMC's updated projections for 2023 suggest a 2.6% annualized growth in GDP, a half percentage point increase from their September forecast. The outlook for 2024 remains stable at a 1.4% growth rate. The unemployment rate projections remain largely unchanged, expected to be 3.8% in 2023 and gradually rising to 4.1% in the following years.
The Fed officials have expressed their readiness to increase rates again if inflation resurges. However, most members agree on a more patient approach currently, as they assess the impact of previous policy tightening on the U.S. economy.
Source: FEderak Reserve Bank of New York, CNBC, Jeff Cox, Loan Analytics
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