Federal Reserve officials began a two-day FOMC policy meeting this Tuesday. Nick Timiraos, a well-known financial journalist known as the “New Federal Reserve News Agency,” quoted the old Chinese proverb “do nothing” at the beginning of his latest forward-looking article on the conference, believing that this might summarize the Federal Reserve's latest interest rate policy policy.

Timiraos said that the Federal Reserve is expected to keep the benchmark federal funds rate unchanged at the highest level in more than 20 years, that is, around 5.3%. He pointed out that US inflation in the first three months of this year was higher than expected, which may delay the schedule for the Federal Reserve to cut interest rates in the foreseeable future. Federal Reserve officials may emphasize that they are prepared to keep interest rates unchanged for longer than previously anticipated, so that interest rates can be at a level that most officials expect to have a clear inhibitory effect on US economic activity.

The Federal Reserve will not announce new economic forecasts at this meeting, and its policy statement is expected to have only minor changes, so Federal Reserve Chairman Powell's press conference on Wednesday will be the focus. Here are a few points Timiraos believes require close attention.

Inflation progress has suffered a setback

Since the March meeting, the US economy has continued to show strong momentum. But the inflation performance has been disappointing. Previously, in the second half of 2023, a series of data on cooling inflation had aroused optimism, and it was widely believed that the Federal Reserve would be able to cut interest rates.

Powell said in March that the strong price pressure in January of this year was only a “bump” in the path of falling inflation. However, the subsequent February and March data, although not as hot as January, were still strong, breaking this optimism. The relevant data raised the outlook that US inflation may eventually hover around 3%, while the Federal Reserve's inflation target remains at 2% for a long time.

Powell is likely to repeat his message two weeks ago at this week's press conference. At the time, he said that recent data clearly did not give us more confidence that inflation will continue to fall to 2%; on the contrary, the data suggests that achieving this target may take longer than expected.

The focus of this conference will be how Powell describes interest rate prospects. Although most Wall Street strategists believe that the Fed is still likely to cut interest rates once or twice later this year, carrying out such adjustments without clear evidence of the weakness of the US economy is still more variable than just a few weeks ago. Some even think the Federal Reserve might not cut interest rates at all.

The Fed's interest rate outlook depends on its inflation forecast, and the latest data suggests two possibilities:

• First, the Federal Reserve's previous inflation expectations are still applicable; that is, inflation continues to decline but is uneven and uneven; it is only more volatile. Under these circumstances, interest rates will still be cut this year, but interest rate cuts may be delayed, and the pace of interest rate cuts will slow down.
• The second possibility is that instead of “bumpy” inflation reaching 2%, it has fallen to a level close to 3%. If there is no evidence that the US economy is slowing more clearly, then the reason for cutting interest rates may be completely eliminated.

The interest rate policy is still in place

Powell may admit that the confidence of officials about when and how much interest rates will be cut is weaker than before. In March of this year, the vast majority of officials expected to cut interest rates two or more times this year, with a slight majority of those expecting to cut interest rates at least three times.

Although officials will not submit new economic forecasts this week, Powell still has an opportunity to reconfirm the old predictions from the previous meeting or announce that they are out of date at other meetings in the past where economic forecasts were not published. This Wednesday's meeting is more likely to result in the latter, that is, the March forecast is out of date.

Meanwhile, Federal Reserve officials said they are generally satisfied with the current policy stance. This means it is unlikely that the Federal Reserve will turn hawkish and consider raising interest rates. Powell said in mid-April, “Policies are in the right place to address the risks we face. If inflation continues to strengthen, the Federal Reserve will keep interest rates at current levels for a longer period of time.”

As participants in the financial market expect interest rate cuts to be small, the yield on long-term US bonds will rise. In fact, this achieved the effect of tightening the financial situation that the Federal Reserve sought when it raised interest rates last year. The rise in the US Treasury yield curve should eventually hurt the value of assets, including stocks, and slow down economic growth.

Hawks are less at risk of turning

Currently, the difficulties faced by Federal Reserve officials in communicating their outlook come down to their proposed “if/if” conditional statements, which are based on a set of results. When America's economic performance is different from what Federal Reserve officials expected, their previous statements may no longer be valid.

As a result, it may be difficult for Powell to rule out any additional interest rate hikes, even if it is still too early for Federal Reserve officials to take a substantial step in this direction.

However, for the time being, it is unlikely that there will be a hawkish shift, which suggests that interest rate hikes are more likely than interest rate cuts. Any such transformation is likely to unfold gradually over a longer period of time. This requires some new severe supply shocks, such as a significant rise in commodity prices, signs of another acceleration in wage growth, and evidence that the public expects higher levels of inflation to continue for a long time to come.

A key wage growth indicator released on Tuesday showed that the continued cooling of US wage growth last year may have stalled in the first quarter. The US Department of Labor said that private sector workers' compensation increased 4.1% year-on-year in the first quarter, which is roughly the same as the fourth quarter of last year.

Signs that wage pressure is easing are an important factor in easing concerns among some Federal Reserve officials about continued inflation in the service sector. Federal Reserve officials may be uneasy if there is further evidence of accelerated wage growth in the next few months.

Federal Reserve balance sheet

Federal Reserve officials said earlier that they may soon announce a reduction in quantitative austerity (QT). As a result, analysts expect the Federal Reserve to officially announce the QT reduction plan at this week's meeting, while others think the Fed may announce it at the June meeting.

The Federal Reserve officially began quantitative austerity in June 2022. Currently, each month, up to $60 billion in US Treasury bonds and up to $35 billion in mortgage bonds are allowed to mature without buying new securities.

At the March meeting this year, Federal Reserve officials seemed to have agreed on a plan to “roughly halve” the rate of asset decline. Since high interest rates keep the reduction in mortgage bonds at a low level, officials will not change this part of the QT. The reduction in QT is for the US Treasury bond portion and lower the monthly reduction limit.

The latest changes have nothing to do with interest rate policies; the aim is to avoid the chaos in the overnight lending market that occurred five years ago.

The Federal Reserve's balance sheet reduction is also gradually draining bank deposits held at the Federal Reserve in the financial system; these deposits are known as reserves. Federal Reserve officials don't know when reserves will become scarce enough to boost yields in the interbank lending market. Therefore, many officials believe that it is better to slow down this process now, as this may allow the decline in the Fed's asset portfolio to continue for a longer period of time without facing the risk of market turmoil that occurred in 2019.