The Federal Reserve held its key interest rate steady for a third time but signaled inflation had cooled more rapidly than anticipated, setting the table for multiple cuts in 2024. Anthony Okolie speaks with Derek Burleton, Deputy Chief Economist at TD, about the Fed’s latest rate decision.
Print Transcript
* As expected, the Fed held its key rate steady but struck a more dovish tone in the last policy meeting of the year. Derek, what stood out for you today?
* Yeah, it was like Santa came a little bit early this year. The statement, the forecast changes, they stood out. First on the statement-- adding the word "any" in front of the extent to which additional tightening may be required certainly was a step in the dovish direction.
* I think for me, also, the forecast changes-- talk about Goldilocks. The Fed is looking at quite a bit lower inflation rate through 2024 than expected, getting fairly close to 2% by the end of next year. That was marked down. They've got stronger growth than they had in September.
* And yeah, so I think those two things, for sure, suggested a Fed that is feeling better about the economy, feeling better about inflation. But I was surprised. I thought it would be more cautionary. And I did notice when I listened to Powell in his presser, he hasn't changed his tone that much.
* So I would consider this to be a shift down, a pivot, a shift down the more dovish tone. But I don't see 180 degrees here. I still see a central bank that hasn't quite said popping the champagne corks at all. Everything's clear towards rate cuts. I think that still remains a question as to when they might be cutting rates.
* OK, so given this more dovish tone, do you think there's a risk that we could see financial conditions loosening even more after today's meeting?
* Well, in fact, right after, we see, and this is something I think we were all wondering-- are they going to try and talk the markets closer to their prevailing view? Or are they going to move closer to the markets when you see the immediate reaction? They moved closer to the markets, but the markets moved again, building even looser financial conditions.
* Now, looking at Fed funds futures, more than a 60% odds of a cut as early as March. And you compare their dot plot forecasts, they've lowered that quite a bit in terms of year end rate levels-- the median dot interest rate forecast. But that only builds in 80 basis points of easing. But the market is now looking at about 135. So that gap continues to widen, and a bit of a concern in that the looser conditions get, then it's going to be tougher for the Fed to see the kind of inflation forecasts they've got in their updated forecast.
* OK, so given that backdrop, what are some of the key indicators you'll be watching as the Fed considers its next move?
* Well, the big one is inflation. I think they kind of suggested that the growth-- I think they're putting less emphasis on the growth side of the equation, that idea that pain needs to be inflicted to achieve 2% inflation. I certainly think they've lightened that perspective. Powell, again, referred to the supply chain improvements we're seeing, that we can get this sort of Goldilocks immaculate disinflation without seeing growth slow dramatically.
* So that's one thing. I think it really boils down, in large part, to inflation. I think they've got their preferred measure, they've got CPI as well. We don't have as optimistic a view on the Fed on inflation.
* I think we're building in more of the risk that it's going to be a little bit turbulent getting from kind of 3% inflation, where we're at now overall, down to 2%. And so I think given that, I think we may see some volatility in the bond market going forward. Ultimately, the data has to align with the Fed's view or else the market's got to shift its stance.
* Now, you mentioned we saw a lot of volatility in the bond market. We've also seen some movement in the FX market. Where do you see the US dollar going in the next little while?
* Well, before, I was thinking strength in the US dollar. But this is a bit more of a shift in terms of the forecast and the statement. We may see some near-term US dollar weakness. We'll see. We've got other big central banks meeting this week-- ECB, Bank of England. And they can change kind of the dynamic in foreign exchange.
* But what we may see in the near term is US dollar weakness. But I think, again, my view is going out into the early part of next year, the US dollar will gain some legs. US economy will be the best performing economy. You get that macho effect, investors chasing into the best performing economy, but I don't see a lot of US dollar weakness.
* In fact, I would see some reversion. And that's going to mean probably a weaker Canadian dollar beyond the very near term, where we may see a bit of a pop.
* Derek, thanks very much for your time.
* Thank you very much.
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* Yeah, it was like Santa came a little bit early this year. The statement, the forecast changes, they stood out. First on the statement-- adding the word "any" in front of the extent to which additional tightening may be required certainly was a step in the dovish direction.
* I think for me, also, the forecast changes-- talk about Goldilocks. The Fed is looking at quite a bit lower inflation rate through 2024 than expected, getting fairly close to 2% by the end of next year. That was marked down. They've got stronger growth than they had in September.
* And yeah, so I think those two things, for sure, suggested a Fed that is feeling better about the economy, feeling better about inflation. But I was surprised. I thought it would be more cautionary. And I did notice when I listened to Powell in his presser, he hasn't changed his tone that much.
* So I would consider this to be a shift down, a pivot, a shift down the more dovish tone. But I don't see 180 degrees here. I still see a central bank that hasn't quite said popping the champagne corks at all. Everything's clear towards rate cuts. I think that still remains a question as to when they might be cutting rates.
* OK, so given this more dovish tone, do you think there's a risk that we could see financial conditions loosening even more after today's meeting?
* Well, in fact, right after, we see, and this is something I think we were all wondering-- are they going to try and talk the markets closer to their prevailing view? Or are they going to move closer to the markets when you see the immediate reaction? They moved closer to the markets, but the markets moved again, building even looser financial conditions.
* Now, looking at Fed funds futures, more than a 60% odds of a cut as early as March. And you compare their dot plot forecasts, they've lowered that quite a bit in terms of year end rate levels-- the median dot interest rate forecast. But that only builds in 80 basis points of easing. But the market is now looking at about 135. So that gap continues to widen, and a bit of a concern in that the looser conditions get, then it's going to be tougher for the Fed to see the kind of inflation forecasts they've got in their updated forecast.
* OK, so given that backdrop, what are some of the key indicators you'll be watching as the Fed considers its next move?
* Well, the big one is inflation. I think they kind of suggested that the growth-- I think they're putting less emphasis on the growth side of the equation, that idea that pain needs to be inflicted to achieve 2% inflation. I certainly think they've lightened that perspective. Powell, again, referred to the supply chain improvements we're seeing, that we can get this sort of Goldilocks immaculate disinflation without seeing growth slow dramatically.
* So that's one thing. I think it really boils down, in large part, to inflation. I think they've got their preferred measure, they've got CPI as well. We don't have as optimistic a view on the Fed on inflation.
* I think we're building in more of the risk that it's going to be a little bit turbulent getting from kind of 3% inflation, where we're at now overall, down to 2%. And so I think given that, I think we may see some volatility in the bond market going forward. Ultimately, the data has to align with the Fed's view or else the market's got to shift its stance.
* Now, you mentioned we saw a lot of volatility in the bond market. We've also seen some movement in the FX market. Where do you see the US dollar going in the next little while?
* Well, before, I was thinking strength in the US dollar. But this is a bit more of a shift in terms of the forecast and the statement. We may see some near-term US dollar weakness. We'll see. We've got other big central banks meeting this week-- ECB, Bank of England. And they can change kind of the dynamic in foreign exchange.
* But what we may see in the near term is US dollar weakness. But I think, again, my view is going out into the early part of next year, the US dollar will gain some legs. US economy will be the best performing economy. You get that macho effect, investors chasing into the best performing economy, but I don't see a lot of US dollar weakness.
* In fact, I would see some reversion. And that's going to mean probably a weaker Canadian dollar beyond the very near term, where we may see a bit of a pop.
* Derek, thanks very much for your time.
* Thank you very much.
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