Weekly Update - Federal Reserve: A pause while waiting for a better inflation climate

The Federal Reserve (Fed) has decided to keep its interest rate policy unchanged while moderating its pace of balance sheet reduction. The Fed's caution is in response to the upward inflation surprises in the first quarter of the year, which has been slower than expected to converge towards 2%. However, we continue to expect the Fed to begin a very gradual rate cut cycle in the third quarter, with inflation and activity expected to moderate gradually.

The Fed is keeping the pause. As anticipated by the markets, the Fed kept its monetary policy range at 5.25%-5.50%, thus maintaining its key rates at this level since August 2023. The small surprise of the meeting came from its balance sheet policy, as the Fed decided to reduce its Treasury runoff pace from USD 65 billion per month to USD 25 billion. While markets were expecting a change in tone from the Fed given the acceleration of inflation in the first quarter and a potential talk of a scenario of renewed rate hikes, Mr. Powell maintained a balanced or even slightly dovish tone. Indeed, while acknowledging that the latest inflation figures show "it's going to take longer to gain confidence" that inflation is converging towards the 2% target, Powell specified that his three scenarios are those of i) a rate cut due to lower inflation, ii) a rate cut due to a deterioration in employment and iii) rates remaining at current levels. He reiterated that financial conditions remain restrictive.

Inflation surprises linked to housing prices and micro factors. While markets were expecting a sharp rate cut cycle in January, the acceleration of core inflation in the first quarter to 3.7% QoQ effectively pushed back the timing of rate cuts and called into question the possibility of such cuts. However, we believe that this figure does not call into question the disinflationary dynamic. Indeed, on the one hand, the acceleration in inflation corresponds to the sharp increase in January, the result of strong seasonal adjustments. Inflation in February and March showed a slow normalisation. On the other hand, housing prices continue to help keep inflation high. This market remains tight due to demographics and low pressure to sell in a fixed-rate environment. Nevertheless, we do not expect a further acceleration in prices in this sector.

A rebalancing of the labour market and a slowdown in activity support the rate cut scenario. Mr. Powell's press conference, and our scenario of a gradual slowdown in inflation and activity, maintain our scenario of the beginning of the rate cut cycle in Q3-24. First, the labour market continues to rebalance, with the number of unfilled positions and of resignations decreasing and now close to their 2019 levels. On the other hand, wage growth continues to moderate, including in the services sector, pointing to a further moderation in inflation and consumption. Finally, in a context of a real rate of 2.8% and the Fed's dual employment-inflation mandate, a start of the easing cycle seems justified.