A change to this one clause could be the most important part of the Fed meeting

U.S. Federal Reserve Chair Jerome Powell attends a press conference in Washington, D.C., on Dec. 13, 2023.

Liu Jie | Xinhua News Agency | Getty Images

Immediately after the Federal Reserve wraps up its meeting this week, all eyes are likely to gravitate to one small piece of wording that could unlock the future of monetary policy.

In its post-meeting statement, the central bank is expected give an important hint about interest rate moves to come by removing a clause from previous statements that reads: “In determining the extent of any additional policy firming that may be appropriate to return inflation to 2 percent over time,” followed by an outlining of conditions it assesses.

For the past year-plus, the wording has underlined the Fed’s willingness to keep raising interest rates until it reaches its inflation goal. Remove that clause and it opens the door to potential rate cuts ahead; keep it and policymakers will be sending a signal that they’re not sure what’s to come.

The difference will mean a lot to financial markets.

Amending the wording could amount to a “meaningful overhaul” of the Federal Open Market Committee’s post-meeting statement, and its direction, according to Deutsche Bank economists.

“We heard at the December meeting that no official expected to raise rates further as a baseline outcome. And we’ve heard that Fed officials are beginning the discussions around rate cuts,” Matthew Luzzetti, Deutsche Bank’s chief U.S. economist, said in an interview. “So getting rid of that explicit tightening bias is kind of a precondition to more actively thinking about when they might cut rates, and to leaving the door open for a March rate cut.”

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While the market has accepted for months that the Fed is likely done raising rates, the most burning question is when it will start cutting. The Fed last hiked in July 2023. Since then, inflation numbers have drifted lower and are, by one measure, less than a percentage point away from the central bank’s 2% 12-month target.

Just a few weeks ago, futures markets were convinced the Fed would start in March, assigning a nearly 90% probability to such a move, according to the CME Group’s FedWatch gauge. Now, there’s considerably more uncertainty as multiple statements from Fed officials point to a more cautious approach about declaring victory over inflation.

Reading the tea leaves

Chairman Jerome Powell will have a thin line to walk during his post-meeting news conference.

“They’re going to get a lot of data between the January and March meetings, particularly as it relates to inflation,” Luzzetti said. “How those data come in will be critical to determining the outcomes of future meetings. He’ll leave it open, but will not try to open it any more than what the market already has.”

For this meeting, it will be harder to decipher where the full FOMC is heading as it will not include the quarterly “dot plot” of individual members’ projections.

However, most of the public statements that officials have delivered in recent days point away from a hurry to cut. At the same time, policymakers have expressed concern about over-tightening.

The fed funds rate, currently targeted in a range between 5.25% and 5.5%, is restrictive by historical standards and looks even more so as inflation drops and the “real” rate rises. The inflation rate judged by core personal consumption expenditures prices, a U.S. Department of Commerce measure that the Fed favors, indicates the real funds rate to be around 2.4%. Fed officials figure the long-run real rate to be closer to 0.5%.

“The main thing that they will probably want to do is gain a lot of optionality,” said Bill English, the former head of monetary affairs at the Fed and now a finance professor at the Yale School of Management. “That would mean saying something rather vague at this point [such as] we’re determining the stance of policy that may be appropriate or something like that.”

Preparing for the future

Post-meeting statements going back to at least late 2022 have used the “in determining the extent of any additional policy firming” phrasing or similar verbiage to indicate the FOMC’s resolve in tightening monetary policy to bring down inflation.

With six- and three-month measures showing inflation actually running at or below the 2% target, such hawkishness could seem unnecessary now.

“In effect, that’s saying that they’re more likely to be raising than cutting,” English said of the clause. “I guess they don’t think that’s really true. So I would think they’d want to be ready to cut rates in March if it seems appropriate when they get there.”

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Officials will be weighing the balance of inflation that is declining against economic growth that has held stronger than anticipated. Gross domestic product grew at an annualized pace of 3.3% in the fourth quarter, lower than the previous period but well ahead of where Fed officials figured it would be at this stage.

Traders in the fed funds futures market are pricing in about a 60% chance of a cut happening in March, the first of five or six moves by the end of 2024, assuming quarter-percentage-point increments, according to the CME Group’s FedWatch gauge. FOMC members in their latest projections in December pointed to just three reductions this year.

The Fed hasn’t cut as aggressively as traders expected absent a recession since the 1980s and that “led to excess investor confidence culminating in the 1987 stock market crash,” Nicholas Colas, co-founder of DataTrek Research, said in his daily market note Monday evening.

Yet, Goldman Sachs economists said they figure the Fed will “remove the now outdated hiking bias” from the post-meeting statement and set the stage for a cut in March and five total on the year. In a client note, the firm said it also figures the committee could borrow a line from the December meeting minutes indicating it would “be appropriate for policy to remain at a restrictive stance until inflation is clearly moving down sustainably toward the Committee’s objective.”

However, a restrictive stance isn’t the same as holding rates where they are now, and that kind of linguistic move would give the committee wiggle room to cut.

Markets also will be looking for information on when the Fed begins to reverse its balance sheet runoff, a process that has seen the central bank reduce its bond holdings by about $1.2 trillion since mid-2022.

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