WisdomTree Minds on the Markets
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Minds on the Markets
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Minds on the Markets
Archive: January 16, 2024
The Fed’s Balancing Act
The word “balance” takes on two different meanings for the Federal Reserve (Fed). The first definition reflects how the policy maker is looking at the data in its decision-making process while the second aspect refers to its balance sheet. Either way, it looks like both meanings will be in play this year for Powell & Co.
Let’s take a look at the first of these meanings. As we begin this process, we must keep in mind the Fed’s two monetary policy mandates: inflation and employment. Up until the December 2023 meeting, the Federal Open Market Committee (FOMC) was no doubt laser-focused on the former, not necessarily the latter. According to the voting members, it appears their approach centered on the notion that the labor markets were in solid shape, so let’s just concentrate on stopping the spike in price pressures and ultimately bringing inflation down toward their 2% threshold.
Although, to hear the Fed talk, “there’s still more work to do” with respect to inflation, enough progress had been made so it could turn its attention back toward the jobs portion of the mandate. In other words, the policy maker had become more sensitive to the possibility that its 525 basis points (bps) worth of rate hikes could create the unintended consequence of softening labor market conditions too much.
As a result, Chairman Powell stated at the December FOMC presser that the Fed is “getting back to the point where both mandates are important.” This point was echoed by Cleveland Fed President Mester (a 2024 FOMC voting member until later this year, when she is expected to step down) last week when she said that “this year is going to be more about looking at the balance now between both parts of our mandates.” Perhaps it’s also interesting to point out that Mester also mentioned that March is “probably too early for a rate cut,” but more on that in another weekly commentary.
Now, for the “balance” sheet part of the equation. While the Fed did not make any changes to its balance sheet reduction plans at last month’s FOMC meeting, altering the pace of quantitative tightening (QT) has come into focus to begin the new year. To be sure, the December FOMC minutes highlighted how the policy maker thought it would be appropriate to begin discussing the technical factors—i.e., reserve balances—that would guide its decision to slow down the pace of QT and that it wanted to get out in front of this decision so it could provide “advance notice to the public” beforehand.
Interestingly, since these minutes were released in the first week of January, both Mester and Dallas Fed President Logan have touched on balance sheet runoff in recent remarks, with both offering somewhat different views on whether QT should be slowed down. It came to a head last week when NY Fed President Williams, one of the Big 3 who speaks officially on behalf of the Fed, apparently felt the need to weigh in on the matter and pushed back on the notion that a QT taper could be coming sooner rather than later, stating “so far, we don’t seem to be close to that point.”
The bottom-line message is that even though the Fed seems to be at a disconnect with the market on the timing and magnitude for rate cuts, and now perhaps QT developments, both of these factors are seemingly on the table as very important monetary policy decisions that will need to be monitored as 2024 progresses.
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