The Fed Won’t Cut Rates at This Week’s Meeting. Focus on This Instead.

The Federal Reserve’s policy committee will confer on Tuesday and Wednesday, with officials likely to confirm a cautious and gradual approach to changing interest rates in 2024. The Fed’s balance sheet plans may get more attention.

The Federal Open Market Committee will conclude the two-day meeting on Wednesday. It will publish a policy decision at 2 p.m. ET, followed by a press conference with Chairman Jerome Powell at 2:30 p.m.

Futures markets are overwhelmingly pricing in no chance of a change in interest rates at the meeting: the implied odds of a cut on Wednesday were recently around 2%, according to the CME FedWatch Tool. The FOMC has held its federal-funds rate target at a range of 5.25% to 5.50% since July 2023.

In recent public statements, several policymakers have said they’re in need of more evidence that inflation is trending sustainably toward their 2% annual target after hot readings so far in 2024. Until then, the Fed is in a wait-and-see mode. A resilient labor market and economic growth mean there’s no huge rush to lower interest rates either.

“It’s really going to be about how they’ve changed their language on the inflation outlook,” says Jake Schurmeier, a portfolio manager at Harbor Capital Advisors. “Back in March, the message was ‘there will be some bumps in the road.’ When Powell last spoke [on April 16,] he acknowledged reality and basically said that inflation hasn’t made the progress that was expected.”

Don’t expect Powell to be particularly specific on the timing of any change in interest rates, rather emphasizing policymakers’ data-dependent approach.

There may be more details regarding the Fed’s balance sheet plans. Banks hold reserves at the Fed, and will borrow and lend cash to each other for very short periods—often just overnight—to meet short-term needs or generate a return on their excess cash, most often using U.S. Treasurys as collateral. That market for so-called repurchase agreements, or repos, is worth several trillions of dollars per day.

In addition to setting the benchmark interest rate that banks earn on their reserves, the Fed can influence the stance of monetary policy via the repo market and changes in the size of its balance sheet. Large-scale purchases of assets—called quantitative easing—add cash to the system, making borrowing cheaper. The opposite is called quantitative tightening, or QT.

The Fed has been engaged in QT since June 2022, allowing $60 billion in Treasuries and $35 billion in mortgage-backed securities to mature monthly without reinvesting the proceeds—pulling cash out of the financial system. After the last FOMC meeting in March, Fed Powell said that it would be time to begin slowing the balance-sheet runoff “fairly soon.” That could mean a formal plan in May, followed by a halving of the monthly pace in June or July.

The Fed’s balance sheet has declined from nearly $9 trillion at its 2022 peak—after doubling since the start of the Covid-19 pandemic—to about $7.4 trillion last week. There’s also the Fed’s overnight reverse repurchase, or RRP, facility, which also transacts with other financial institutions beyond banks, including money-market funds and government-sponsored enterprises like Fannie Mae.

The overnight RRP balance has been declining for the past year—adding cash to the banking system faster than QT has been pulling it out. It was around $465 billion on Friday, down from about $2.4 trillion a year earlier. At the current pace, the facility will be close to zero by the end of June. After that, QT will come directly out of bank reserves.

“Ultimately, that’s the whole point of QT: to reduce the size of the balance sheet,” Schurmeier says. “That’s going to have to come from reserves.”

The Fed’s goal is to ensure that reserves in the banking system are “ample.” But what exactly that means is a subject of debate. One Fed estimate suggests that ample reserves are around 10% of gross domestic product. That proportion had recently declined to 12%.

“To me, it’s one of those things that you will know it when you see it, when reserves are no longer ample,” says Antulio Bomfim, head of global macro for the global fixed income team at Northern Trust Asset Management. “I think they learned that lesson in a painful way in 2019.”

In September 2019, repo rates spiked suddenly and dramatically as the banking system found itself short of cash—prompting the Fed to wind down an earlier round of QT ahead of schedule in order to bring rates back down.

By slowing down the pace of QT in 2024, the Fed can reduce the chance of another similar episode of financial market stress, the thinking goes. It doesn’t mean the balance sheet would shrink less than it otherwise would overall, however—it might just take longer to get there, Powell said in March.

Write to Nicholas Jasinski at [email protected]