Federal Reserve and Bank of England: not rocking the boat

Connecting the dots at the Federal Reserve

The Federal Reserve (Fed) voted to leave the target range unchanged at 5.25%-5.50% at the conclusion of its March policy meeting, which was widely expected by the market.

What the market was more interested in was joining the ‘Dots’ (Dot plot, that reflects projections from Fed officials) to see what picture it painted for the future path of interest rates. The initial interpretation and subsequent market reaction was to push treasury yields higher as the ‘Dots’ suggested that a number of Fed officials had reduced the chances of three rate cuts this year and in addition had pushed up the longer-term median terminal rate from 2.50% to 2.60%.

Small beer I hear you shout…and this sentiment was echoed by Fed Governor Jerome Powell in the press conference. He was much more dovish than the ‘Dots’ suggested and re-clarified that interest rates would still be cut at some point later this year so long as it was supported by the economic data, but was not bold enough to assign that probability to a specific meeting. The market has hedged its bets and is now pricing a 50/50 chance that the Fed begin cutting rates at either the June or the July meeting.

Steady as she goes

The key criteria to assessing whether the Fed will begin its rate cutting cycle in the summer still boils down to the strength of the economic data. Powell described the recent stronger inflation prints as “bumps in the road”, however a continued run of strong economic data could turn into a pothole that derails the juggernaut of rate cuts the market is expecting. The mantra that Powell wanted to leave the market with was ‘steady as she goes’, which I think he managed to deliver with aplomb. The treasury market eventually rallied, led by shorter dated bonds (steepening the yield curve), but the magnitude of the overall moves were muted. Back to watching the data and continuing to join the dots!

Bank of England also on hold

At yesterday’s Bank of England (BoE) meeting, the committee voted to keep rates on hold at 5.25%. Whilst this was widely expected by the market, it was the vote split which drew the most attention. At the February meeting the committee was split 1-6-2: one member calling for a rate cut, six voting to keep rates on hold, and two members calling for an additional increase in base rate. Markets had expected that to shift to 1-7-1, but in a surprise turn, the committee voted 8-1 to keep rates on hold; there were no members calling for a further rate hike. The balance of the committee has shifted once again, and there is little doubt now that rate cuts are simply a matter of time.

So when is the cut coming?

Prior to the meeting, August 2024 was seen by many as the most likely date for a first rate cut. But with no members calling for a rate hike, the market has brought forward the expectations of a rate cut. The market now believes June 2024 is very much in play, and the probability of a cut as early as May 2024 being around 20% priced. The main market reaction has seen the yield curve steepen, with yields on shorter maturity bonds little changed, and yields on longer maturity bonds edging higher. Given the vote split, it’s hard to argue against this reaction. However, the BoE will still be watching economic data carefully over the next few months. The strength of Thursday’s Purchasing Managers' Index data, ongoing labour market tightness, and the higher-than-expected Consumer Price Index service inflation data on Wednesday morning, suggest May 2024 could still be a little early for the BoE.

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