Fed Adjusts to Weakening Economy With Changes to Quantitative Tightening
The FOMC policy statement included some significant changes and a clue about coming rate cuts.
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I usually start my assessment of official FOMC policy statements by noting that what was released was little more than another cut-and-paste job.
For the most part, this was true again at 2:00 p.m. ET on Wednesday. Most of the verbiage was taken word for word from past statements. However, some of the items that really matter have changed without changing what we might consider to be the most important item within. That would be the target range for the federal funds rate, which was left where it was at 4.25% to 4.5%. Beyond that, things get interesting. Maybe very interesting.
The Fed Policy Statement
The first paragraph of Wednesday's statement was left as is. However, things get juicy in the second paragraph, as the committee is now clearly concerned over the health of the U.S. economy.
The sentence from January's statement, "The Committee judges that the risks to achieving its employment and inflation goals are roughly in balance" has been deleted and replaced with, "Uncertainty around the economic outlook has increased."
Translated from PhD economist to regular Joe, that's like saying, "Holy snap, Batman... you may want to buckle your helmet."
Later in the statement, after leaving the fed funds rate alone, we get to the part where the balance sheet rundown, or "quantitative tightening" program is mentioned. The following passage:
"The Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage‑backed securities."
...was deleted and replaced with:
"Beginning in April, the Committee will slow the pace of decline of its securities holdings by reducing the monthly redemption cap on Treasury securities from $25 billion to $5 billion. The Committee will maintain the monthly redemption cap on agency debt and agency mortgage-backed securities at $35 billion."
I had mentioned in my Market Recon column on Wednesday morning that, with the economy starting to slow, the Fed may want to put a halt to its QT program. Well, we did not get exactly what I called for, but we did get something. The FOMC has acknowledged the weakening economic data and at least significantly slowed down its rundown of Treasury holdings held on its balance sheet.
The committee left the pace of the runoff of agency debt and agency mortgage-backed securities as it was, which is at least understandable. There is no immediate need to have the central bank continue to reinvest maturing mortgage-backed debt securities en masse, nor has there been for quite some time. Turning that dough as it matures into Treasury debt securities is appropriate and will help maintain a certain level of liquidity in terms of the monetary base.
Implementation of Changes to Quantitative Tightening Program
From the implementation note that was included with the material:
- Roll over at auction the amount of principal payments from the Federal Reserve's holdings of Treasury securities maturing in March that exceeds a cap of $25 billion per month. Beginning on April 1, roll over at auction the amount of principal payments from the Federal Reserve's holdings of Treasury securities maturing in each calendar month that exceeds a cap of $5 billion per month. Redeem Treasury coupon securities up to these monthly caps and Treasury bills to the extent that coupon principal payments are less than the monthly caps.
- Reinvest the amount of principal payments from the Federal Reserve's holdings of agency debt and agency mortgage-backed securities (MBS) received in each calendar month that exceeds a cap of $35 billion per month into Treasury securities to roughly match the maturity composition of Treasury securities outstanding.
Economic Projections
Some of the changes made to the Fed's quarterly economic projections since they were last made in December are quite notable. The median expectation for 2025 GDP growth has dropped to 1.7% from 2.1% as the range of expectations has dropped to 1% to 2.4% from 1.6% to 2.5%. The median expectation for 2025 Unemployment was taken up a notch from 4.3% to 4.4%. The range narrowed for 2025 unemployment from 4.1% to 4.6% to 4.2% to 4.5%.
The Fed seems unimpressed with the slowing of inflation in February that I have told you is very likely to slow further into March. Either it is unimpressed, or it just can't see that far. This is the Fed, so there is always a certain level of "deer in the headlights" type mentality going on.
The committee increased its median expectation for 2025 headline level consumer inflation from 2.5% to 2.7%, while increasing its median expectation for core inflation from 2.5% to 2.8%. My guess is that this is due to the long-held notion that increased tariffs will lead to increased inflation though a slowing economy would certainly pressure consumer prices.
The FOMC made projections on out to 2027 and beyond but given how much their views have changed in three months; I think it makes sense to look no further than this year. These may be for the most part PhD economists. I don't think that qualifies too many of them as rocket scientists.
Most Importantly...
The Fed left its median expectation for the fed funds rate at 3.9%, which is where that expectation was in December. That implies that the Fed will cut the target range for their benchmark overnight rate by 50 basis points to 3.75% to 4% from today's 4.25% to 4.5% by year's end. Financial markets have reacted well to this projection in particular as stocks and bonds have rallied side by side on Wednesday afternoon.
Tomorrow may or may not be another story. Since 2 p.m. on the east coast on Wednesday yields have dropped across the Treasury yield curve from six-month paper all the way out to the long bond, the U.S. dollar index has dropped like a stone and the algorithms that control price discovery have raced into equities.
What I want to know is this: Is the trading volume there to the degree that we can get a "Day One" bullish reversal of trend. Now, that would or could be the start of a ballgame. Without that, this is just trading.
At the time of publication, Guilfoyle had no positions in any securities mentioned.
