The Fed is likely to keep interest rates steady this week. Markets want to know when interest rate cuts will begin.

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The Federal Reserve is widely expected to hold interest rates steady on Wednesday at its first policy meeting of 2024. But investors will be looking for any clues about when cuts could begin.

Will it be March, May or later? The markets may not get a clear answer. But Fed followers expect central bank Chairman Jay Powell to begin preparing investors for an eventual monetary policy easing, even if he does not specify the timing.

“This is the slow turning of the steering warship as they slowly start to talk about interest rate cuts,” said Luke Tilley, chief economist at Wilmington Trust.

Federal Reserve Chairman Jerome Powell in his final press conference on December 13. (Photo by Liu Jie/Xinhua via Getty Images) (Xinhua News Agency via Getty Images)

The question is whether the cuts will happen in March or May It is currently the subject of intense debate on Wall Street as markets approach record highs.

Investors started 2024 with a high degree of conviction that March is when the central bank will begin to ease monetary policy after the most aggressive campaign to cool inflation since the 1980s. Rates are currently at a 22-year high.

But traders then started to reset this expectation Opposition from several central bank officials dampened market expectations for cuts in the first quarter of 2024.

The market’s odds of a March rate cut have fallen to nearly 46%, according to the CME FedWatch tool. This is down from the 71% seen more than a month ago. The probability of a reduction in May is about 51%.

Traders also began revising downward their expectations of six interest rate cuts in 2024, double the median forecast given by all Fed officials in December. The bet now is that five cuts will be made instead.

“Topic for discussion”

These aggressive market expectations first escalated in December when Powell used a news conference following the Fed’s latest policy meeting to suggest that central bank officials had begun the conversation about when to roll back policy restrictions, calling it a “topic for discussion” and a “talking point.” “A theme for us looking forward.”

Low inflation has also encouraged these bets with key measures approaching the Fed’s 2% target.

One such measure emerged last week as the Fed’s preferred measure of inflation — the “core” personal consumption expenditures index that strips out volatile food and energy prices — By 2.9% for the month of December. It was the first time the measure fell below 3% since March 2021.

More encouragingly, core PCE inflation fell to 1.5% year-on-year for three months, the lowest level since late 2020. On a six-month basis it was 1.9% for the second month in a row.

Goldman Sachs chief economist Jan Hatzius expects the Fed will likely start cutting in March, citing Powell’s statement in his December 13 news conference that the committee would want to cut “long before” inflation falls to 2%.

Hatzius also expects five reductions this year, in line with current market expectations.

But Wilmer Stith, bond fund manager at Wilmington Trust, said he believes Powell will try to back away from the number of interest rate cuts the market has set.

“He doesn’t have to hold back too much, but he wants to [expectations] “He has to be in the center so he can have room to move in either direction without causing as much disruption as he would if he were on one side or the other,” Stith said. “This way, if something happens, he is neither pessimistic nor dogmatic.” He can turn around and handle that.”

Wilmington Trust’s Tilley said he believes the Fed will begin preparing markets for rate cuts in March and will actually begin cutting rates in June. A total of five cuts are expected this year.

Tilly is basing his June forecast in part on a similar time lag between when the Fed last started talking about raising interest rates and then actually doing so in March 2022.

“We’ll have to see how the data comes in and we’ll continue to see this slow shift of the warship with communications and every little bit of data that comes in that supports the story and makes it more comfortable with inflation.”

Brett Ryan, chief U.S. economist at Deutsche Bank Securities, expects Fed officials will use this week’s meeting to signal their next pivot by adjusting the language in the official statement issued by the central bank’s Federal Open Market Committee.

It suggests looking at a specific paragraph: “In determining the extent to which any additional policy tightening may be appropriate,” the December statement said, “…the Committee will take into account the cumulative tightening of monetary policy, and the lag in monetary policy.” Politics affects economic activity, inflation, economic and financial developments.”

What he expects is that Fed officials will change “in determining the extent of any additional policy stabilization that may be appropriate” to “in determining future policy adjustments” — which essentially means removing the word “anything.”

He added that this adjustment would remove the central bank’s “strong tightening bias” and leave it with a “kind of neutral bias” – thus paving the way for future cuts.

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