Wednesday, July 24, 2024

Federal Reserve officials stick to rate cut plan prompts market rally

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Federal Reserve officials have indicated they expect to cut interest rates by three-quarters of a percent this year, sending U.S. stock markets to record highs.

The market reaction on Wednesday came after the Federal Open Market Committee voted unanimously to leave rates unchanged at a 23-year high of 5.25 percent to 5.5 percent.

The central bank also sharply raised its forecast for US economic growth this year, while saying inflation would be slightly higher than expected.

The latest report leaves the Fed to begin cutting rates as early as summer, calling time for a mission to curb inflation as the US economy emerges from the Covid-19 pandemic.

Borrowing costs and mortgage rates, which have risen in recent months, will begin to decline just ahead of the presidential election in November.

“The economy is doing well,” Fed Chairman Jay Powell said at a news conference after the FOMC announcement. Officials forecast US gross domestic product to grow 2.1 percent this year, compared with their previous forecast of 1.4 percent.

But with forecasts for core inflation of 2.6 percent this year, slightly higher than expected, Powell signaled that the path to a soft landing could be more complicated.

Inflation was still “on a flat path toward 2 percent at times,” he said, referring to the central bank's official target. “That's why we're approaching this question carefully.”

Concerns about inflation were reflected in the central bank's so-called dot plot. Although officials have indicated they believe rates will end up between 4.5 percent and 4.75 percent in 2024 — the equivalent of a three-quarter-point cut — few expect the central bank to risk deeper cuts.

The central bank's policy statement was little changed from its poll in January, although reference to a slowdown in the labor market was removed. “Job gains remain strong, and the unemployment rate remains low,” the FOMC said.

The market moves came after the Fed cut its rate hike by three quarter points on its schedule for 2024, with some economists warning that recent signs of high inflation could lead to a shift toward two cuts.

The blue-chip S&P 500 rose 0.9 percent to a new record, continuing a rally that has lifted the index 27 percent since October. The Nasdaq Composite rose 1.3 percent.

Two-year Treasury yields, moving in line with interest rate expectations, fell 0.02 percentage points to a one-week low of 4.58 percent. Asian stock markets followed the U.S., with Hong Kong's benchmark Hang Seng index up 1.9 percent and Seoul's Kospi 200 up 2.9 percent. The Stoxx Europe 600 rose 0.9 percent to a record high in early trade on Thursday. Gold hit a fresh high of $2,222 in Asian trade.

“Today's dot plot shows no change in rate cuts, despite the Fed expecting faster near-term growth and slightly warmer inflation,” said Karki Chowdhury, head of Americas iShares investment strategy at BlackRock. “They still think they need to gradually lower rates. I think it's a good outcome for the markets — the stock markets and the bond markets. It's a good outcome for investors.”

As Powell spoke, investors in the futures market added to bets for a rate cut in June, with odds at 85 percent versus 65 percent on Tuesday.

Ishwar Prasad, an economics professor at Cornell University, said: “The central bank's conservative approach is evidenced by incoming data and financial market participants' systematic fall in the path of the central bank's projected interest rates.”

Prasad added: “With no compelling reason to cut interest rates and inflation remaining above target with no room for reduction, the central bank's inaction on interest rates is entirely justified.”

With its more positive outlook for economic growth, the Fed expects headline and core consumer price inflation to reach 2.4 percent and 2.6 percent, respectively, this year, while unemployment will rise to 4 percent from 3.9 percent. In December, the FOMC forecast headline and core CPE inflation for 2024 at 2.4 percent, and unemployment expected to rise 4.1 percent.

Powell suggested that it was too early to know whether recent signs of expected inflation, particularly in the services sector, would last.

“We're going to let the data show. We don't know if it's a bump in the road or something else,” the Fed chief said, adding that he didn't think the latest readings had “changed the whole story.”

The Fed said for now it would maintain the pace of reducing its bond and mortgage-backed securities reserves, known as quantitative tightening.

But Powell said the committee's feeling “is that it's appropriate to slow down the run-off very quickly,” though “that doesn't mean our balance sheet will ultimately shrink any less than that.”

Matthew Raskin, Deutsche Bank's US head of rates research, said he thought the meeting set an overall “dovish” tone because higher growth and inflation forecasts were contrary to officials' expectations that they would be cut as planned.

“What's remarkable about the report is how little change there was. It's probably as small a change in a report as we've seen in a while,” he said.

Additional reporting by Peter Wells in New York

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