Powell Signals Rate Cuts Hinge on Inflation Control

Key Takeaway

• Jay Powell's recent remarks reaffirm the Fed's data-dependent stance, hinting at rate cuts only when inflation is under control, calming markets despite mixed economic signals.
• The real fed funds rate at 2.9%, highest in nearly 17 years, alongside easing financial conditions, raises questions about the sustainability of current monetary policy.
• Market now prices a 60% chance of a June rate cut, down from earlier more aggressive expectations; upcoming employment data and gas prices could significantly influence Fed decisions.

Powell's Reassurance Amid Economic Zigzag

Federal Reserve Chair Jay Powell's recent remarks at Stanford University echoed a familiar but vital message to the markets: the Fed remains data-dependent, with rate cuts contingent upon sustained inflation control. Despite the repetition, Powell's words carry weight, especially in light of recent economic data presenting a mixed picture. On one hand, stronger-than-expected private-sector job growth suggests less urgency for rate cuts. On the other, a benign reading on service sector prices from the ISM survey hints at potential easing. This juxtaposition underscores the Fed's cautious approach to monetary policy adjustments, aiming to avoid premature actions that could jeopardize inflation control efforts.

Market Response and Financial Conditions

The market's reaction to Powell's speech, coupled with fluctuating economic indicators, highlights the ongoing uncertainty and the Fed's significant influence on investor sentiment. Despite a brief spike in the 10-year yield, the bond market stabilized by the close, reflecting the calming effect of Powell's consistent stance. Interestingly, the real fed funds rate's peak at 2.9%, the highest in nearly 17 years, has not tightened financial conditions as one might expect. Instead, market optimism, fueled by anticipation of future rate cuts, has paradoxically eased financial conditions to levels reminiscent of early 2022, raising questions about the sustainability of this disconnect.

The Employment Data Anticipation

The upcoming March employment data stands as the next critical indicator for the Fed's policy direction. Analysts are divided on the implications, with some pointing to a potential rise in inflation trends. The debate centers on the timing and magnitude of future rate cuts, with the market adjusting its expectations in light of recent data. This uncertainty underscores the delicate balance the Fed seeks to maintain: stimulating economic growth without igniting inflationary pressures. Powell's acknowledgment of this balancing act emphasizes the importance of precise timing in any policy adjustments.

Kahneman's Insights on Gas Prices

The late Nobel laureate Daniel Kahneman's work on human rationality and decision-making offers a pertinent lens through which to view current economic concerns, particularly gas prices. Kahneman's concepts of anchoring and framing help explain why fluctuations in gas prices have a disproportionate impact on public perception and economic sentiment. As gas prices cross psychological thresholds, such as $3.50 per gallon, their influence on inflation expectations and presidential approval ratings illustrates the complex interplay between economic indicators and public sentiment. This dynamic serves as a reminder of the broader socio-economic factors at play in monetary policy considerations.

Street Views

• Joseph Lavorgna, SMC Nikko Securities (Neutral on the economy):

  "Historically, when real rates are high for long enough, growth eventually slows. At this point, they want to avoid a more significant slowing in the economy, especially given that the labor market imbalances aren’t as pronounced."

• Steven Blitz, TS Lombard (Neutral on Federal Reserve's rate decisions):

  "The math in my adjusted Taylor Rule illustrates the dilemma. If month-on-month Core PCE inflation averages 4.0% (average of the past three months is 3.5%) between now and June, the year-on-year pace is still sitting at 3.0%, leaving room for a rate cut or two – but the year-on-year would be 4% by year-end, and that says a 6.0% funds rate."