US Fed holds key rates elevated at 23-year high, expects single 0.25% reduction in 2024; 5 key takeaways

The US Federal Reserve announced its fourth interest rate decision for 2024 on Thursday, after a two-day Federal Open Market Committee (FOMC) meeting, where it unanimously voted to leave the key benchmark interest rates unchanged at 5.25 per cent - 5.50 per cent for the seventh straight meeting, which was broadly in line with Wall Street estimates and market analysts.

The US central bank has maintained its key overnight interest rate at the 23-year high-mark since July 2023. Despite US inflation falling further to the target range in recent months, the Fed does not expect to reduce interest rates until it has “gained greater confidence” that inflation is moving sustainably towards its two per cent level. 

Follow US Fed Meeting Outcome Highlights: Powell-led FOMC holds key rates steady at 5.25-5.50% for 7th straight meeting

Fed policymakers also slightly raised the US core inflation forecast for this year compared to the forecast given in the previous policy meeting held in May, but stuck to the US gross domestic product (GDP) growth projections for 2024.

'The Committee seeks to achieve maximum employment and inflation at the rate of two per cent over the longer run. The Committee judges that the risks to achieving its employment and inflation goals have moved toward better balance over the past year,'' said the Fed in today's statement. 'The economic outlook is uncertain, and the Committee remains highly attentive to inflation risks,'' it added.

Earlier today, separate US government data revealed that the annual consumer price index (CPI) came in at 3.3 per cent in May, down 0.1 percentage point from April and unchanged on a monthly basis, which was slightly below Street expectations. The so-called core consumer price index, which excludes food and energy, rose 0.2 per cent in May and 3.4 per cent from a year earlier, the slowest pace since 2021.

US Fed Policy June 2024: Here are 5 key highlights
1.US interest rates at over 2 decade-high

The Fed kicked off an aggressive monetary policy tightening cycle by raising the policy rate by 5.25 percentage points since March 2022 – in one of the swiftest Fed reactions to rising price pressures that had eventually hit a 40-year peak.

The Fed’s rate hikes have helped lower annual inflation from a peak of 9.1 per cent in June 2022 to 3.2 per cent. However, it has made borrowing costlier for businesses and households. The policymakers now face the task of keeping rates high enough to slow spending and defeat high inflation without derailing the economy.

The longer the Fed keeps borrowing costs high, the more it risks weakening the economy too much and causing a recession. Yet if it cuts rates too soon, it risks reigniting inflation, which is still volatile over geopolitical conflicts.

Today's policy statement also repeated that officials are still seeking "greater confidence" in a continued decline of inflation before they begin cutting interest rates, a language adopted at the Fed's January 30-31 meeting that is likely to stay in place until just before the first rate reduction.

Inflation had cooled steadily in the second half of last year, raising hopes that the Fed could achieve a rare ‘soft landing’, where it would manage to conquer inflation through rate hikes without causing a recession. But inflation was unexpectedly high in the first three months of 2024, delaying hoped-for rate cuts and potentially imperiling a soft landing.

2.US Fed projects one rate cut in 2024, four reductions in 2025

The US Fed said in its statement that "modest" progress had been made toward its long-term inflation target of two per cent, adding that they expect only one rate cut in 2024, down from the three projected in March.

The Federal Reserve’s so-called dot plot, which the US central bank uses to signal its outlook for the path of interest rates, shows the median year-end projection for the federal funds rate rose to 5.13 per cent. This means that FOMC participants only expect one 0.25 percentage point cut before year-end.

The median estimate for the end of 2025 increased to 4.13 per cent, implying an additional four quarter-of-a-percentage-point cuts next year. The officials' rate-cut forecast reflects the individual estimates of 19 policymakers. The Fed said that eight of those officials projected two rate cuts and seven projected one cut. Four said they envisioned no cuts at all this year. FOMC participants penciled in an additional four cuts in 2026.

3. Fed to slow down pace of balance-sheet runoff starting in June

The US central bank also announced it will scale back the pace at which it is shrinking its balance sheet starting on June 1, allowing only $25 billion in Treasury bonds to run off each month compared to the current $60 billion. Mortgage-backed securities will continue to run off by up to $35 billion monthly.

The central bank has been winding down its holdings since June 2022 — a process known as quantitative tightening. It gradually increased the combined amount of Treasury and mortgage bonds it allowed to run off without being reinvested to a total of $95 billion per month.

The step is meant to ensure the financial system does not run short of reserves as happened in 2019 during the Fed's last round. ‘’With principal payments of agency securities currently running at about $15 billion per month, the total portfolio runoff will be about $40 billion per month,'' said Powell after the May policy decision.

While the move could loosen financial conditions at the margin at a time when the US central bank is trying to keep pressure on the economy, policymakers insist their balance sheet and interest rate tools serve different ends.

Also Read: Fed policy rate to stay at 2-decade high-mark, US inflation may not drop significantly in 2024: Powell

4.Fed's economic projections from June policy verdict

As part of the updated quarterly economic forecasts issued by Fed, policymakers projected that the economy will grow 2.1 per cent this year and two per cent in 2025, the same as they had envisioned in March. They expect core inflation to be 2.8 per cent by year's end, according to their preferred gauge, up from a previous forecast of 2.6 per cent. 

Fed also expects that unemployment will stay at its current four per cent rate by the end of this year and edge up to 4.2 per cent by the end of 2025. The expectation that the unemployment rate will remain around those low levels indicates that the officials believe that while the job market will gradually slow, it will remain fundamentally healthy.

Also Read: US job openings slide to three-year low as demand for labor gradually eases

The unemployment rate climbed to four per cent in May. US nonfarm payrolls surged by 272,000 in May, surpassing all Wall Street projections The unemployment rate — which is derived from a separate survey — increased to four per cent from 3.9 per cent, rising to that level for the first time in over two years.

Powell described the overall labor market as strong but gradually cooling, comparing it to the state of the jobs market at the cusp of the pandemic. However, he acknowledged that an unexpected weakening could warrant a response by the Fed. Policymakers then expect both growth and inflation to moderate further in 2025.

5.Wall Street rallies on Powell remarks, Dollar retreats

Stocks hit fresh all-time highs even as the Fed did little to change Wall Street’s bets that interest rates will drop at least twice in 2024 — even after the central bank’s more conservative outlook. Fed swaps are still pointing to rate cuts in both November and December.

The S&P 500 topped 5,400 for the first time in its history, with Wednesday marking the 20-month anniversary of the bull market. The Nasdaq composite also built on its own record and jumped 1.5 per cent, while the Dow Jones Industrial Average lagged the market with a dip of 35 points, or 0.1 per cent. The US dollar retreated against all of its developed-world counterparts.

(With inputs from Reuters, Bloomberg)