How will the rotation of the Federal Reserve's voting committee affect the prospect of interest rate cuts?

In less than two weeks, the Federal Reserve will usher in its first interest rate meeting this year.

As usual, the Federal Open Market Committee (FOMC), which has the power to decide monetary policy, will rotate its voting committee. As the current tightening cycle of the Federal Reserve comes to an end, investors have turned their attention to the path of future interest rate cuts based on the recent fluctuations in risk assets. Judging from the latest position distribution within the committee, the current monetary policy is still some distance away from turning to substantial easing.

The new FOMC is more neutral

Affected by retirement and other factors, there have been many replacements and reappointments of officials within the Federal Reserve since 2023. The FOMC currently consists of 12 members, including Fed Chairman Powell, Vice Chairman Philip Jefferson, Michael Barr, Fed Governors Christopher Waller, Lisa Cook, and Adriana Kugler. , Michelle Bowman and New York Fed President John Williams are fixed voting committee members, and the remaining 4 seats are replaced by 11 local Fed presidents on an annual rotation.

Those who will be rotated out this year are Chicago Fed President Austan Goolsbee, Philadelphia Fed President Patrick Harker, Minneapolis Fed President Neel Kashkari and Dallas Fed President Low Roots (Lorie Logan). At the same time, Cleveland Fed President Loretta Mester, Richmond Fed President Thomas Barkin, Atlanta Fed President Raphael Bostic and San Francisco Fed President Mary Daly became new votes Committee.

Rotation list of the Federal Reserve Voting Committee for the next three years (Federal Reserve official website)

China Business News reporters sorted out the recent views of the new voting committee. Hawkish member Mester reiterated the possibility of raising interest rates, stressing that the Fed still has more work to do. "It's hard to predict the future, it depends on how the economy develops. I think March may be too early." Mester said housing costs and wage growth need to slow to bring inflation more in line with the Fed's 2% target .

Other officials are mainly waiting and watching. San Francisco Fed President Mary Daly spoke on the eve of the silence period and said that the U.S. economy and monetary policy are in good shape. While reducing inflation is still ongoing, risks have become more balanced. "We can start to be more patient and see what we need to do next. This requires patience and gradual progress." She emphasized that unlike last year's focus on fighting inflation, this year it is more important to focus on another task of the Federal Reserve - Achieve maximum employment.

The stance of the fixed voting committee also tends to be wait-and-see. Williams, the No. 3 figure in the Federal Reserve and President of the New York Fed, said earlier this month that it was premature to call for an interest rate cut because there is still some way to return inflation to the 2% target. The key Powell adviser also said a restrictive policy stance would need to be maintained for some time to fully achieve the goals. "Only when we are convinced that inflation is continuing to move towards 2% will it be appropriate to reduce the degree of policy restrictions." Williams believes that the economic outlook remains "highly uncertain" and decisions on monetary policy will be based on overall data and constantly changing. The balance of prospects and risks is made one at a time.

Waller, the first member of the voting committee to propose an interest rate cut, also "changed his tune" last week. "With economic activity and labor market conditions in good shape, and inflation gradually falling to 2%, I see no reason to act as quickly as in the past." His statement directly hit the market's previous interest rate cut expectations.

Boris Schlossberg, macro strategist at BK asset management, said in an interview with China Business News that compared with the start of the interest rate hike cycle in March last year, we can clearly see the gradual softening of the Fed's internal stance.

He analyzed that judging from the latest member distribution, the forces within the FOMC are shifting towards a balance, and some members who were originally biased towards hawks and doves are gradually leaning towards a neutral stance. Schlossberg believes that the Fed may not change its cautious attitude until the inflation outlook changes further, which also means that maintaining the status quo is still the best option in the short term.

The prospect of interest rate cuts is unclear

Since March 2022, the Federal Reserve has raised interest rates by a cumulative 525 basis points. In December, the FOMC left the door open to the possibility of a rate cut.

The market generally believes that at the interest rate meeting held at the end of this month, the Federal Reserve kept interest rates stable for the fourth consecutive time. The real focus, however, will be the future. Judging from the recent meeting minutes themselves, there was only preliminary communication within the Fed about cutting interest rates. Some officials have said they are willing to accept a rate cut in the first half of 2024 if inflation falls faster than expected. But officials gave no indication that they planned to use the upcoming meeting to prepare for a rate cut in March.

After recent consumption and employment data show economic resilience, policy changes will not come soon. "The Fed can be patient and wait," said Ellen Zentner, chief U.S. economist at Morgan Stanley, who expects the first rate cut in June. The Fed can take its time because they won't cut interest rates to offset the economic contraction, as has often happened in the past.

History also proves that the Federal Reserve should be cautious when it begins to cut interest rates. In the 1970s, before inflation was truly contained, central banks eased policy too quickly. The policy mistakes of then-Federal Reserve Chairman Volcker plunged the United States into a deeper recession. Atlanta Fed President Bostic said last week that the worst outcome would be for policymakers to lower interest rates and then have to raise rates again later if inflation picks up. “We don’t want to continue this pattern of up and down or back and forth.”

This week the United States will release an important inflation indicator-the personal consumption expenditures price index (PCE). The data may have an impact on the policy path. Hu Gang, a partner at New York hedge fund WinShore Capital Partners, previously said in an interview with China Business News that considering the cost of interest rate cuts and the uncertainty of future inflation paths, Fed officials will not show many thoughts of immediate action for the time being. "In fact, , they are still vigilant now, so I think they are more likely to overturn the market's current rate cut expectations."

Schlossberg told China Business News that investors are beginning to realize that the enthusiasm for cutting interest rates is too high and the path needs to be re-priced. He believes that the focus should be on the labor market, which will determine the speed and extent of interest rate cuts. It may be more appropriate to start easing at the end of the second quarter or the third quarter, so that more data can be available to assess the speed of the economic downturn.

He reminded that the meeting minutes and recent discussions among Fed officials about shrinking the balance sheet mean that this part may be earlier than the interest rate adjustment. With usage of the overnight reverse repurchase facility (On RPP) declining rapidly, there is real reason for a review. This avoids unexpected spikes in interest rates in funding markets, as happened with the turmoil in the repo market in 2019.