US: Federal Reserve expected to keep the Fed funds target range unchanged at 5.25-5.50%

The Federal Reserve is widely expected to keep the Fed funds target range unchanged at 5.25-5.50% on Wednesday while continuing the process of shrinking its balance sheet via quantitative tightening.

At its December FOMC meeting we saw a dovish shift from the Fed, signalling that it expected to cut the policy rate by 75bp this year. Given the perception that the Fed always starts out conservatively and typically ends up shifting policy by more than initially suggested, this was interpreted by markets as giving them the green light to push on more aggressively. Just a few weeks ago seven 25bp moves were being priced by markets for this year with the first cut coming in March, but recent strong jobs and activity data have since scaled that back to a 50-50 call while Fed commentary has also suggested that FOMC members are not in a hurry to cut.

Nonetheless, inflation pressures continue to softenc, with the Fed’s favoured measure of inflation, the core PCE deflator, running at 2% annualised for two consecutive quarters. We think it is only a matter of time before they do indeed cut interest rates, but we think the starting point will be in May. We continue to see some downside risks for growth in the coming quarters relative to the consensus as the legacy of tight monetary policy and credit conditions weighs on activity and Covid-era accrued household savings provide less support. Our forecast is for the Fed funds target range to be cut to 3.75-4% by the end of this year.

On Friday, we have the US jobs report for January. It does feel as though there have been a growing number of job lay-off announcements, but this is not apparent in jobless claims data. We have little survey data to go on at this stage, but given the strength in activity numbers, there seems little reason to expect the jobs market to roll over. We look for payrolls growth of around 200,000, once again led by government, leisure and hospitality and education and healthcare services. Nonetheless, the household survey is expected to show the unemployment rate ticking a little higher to 3.8%.