Key Highlights

• No rate move expected Wednesday; Summary of Economic Projections to be main event
• Uncertainty is still elevated – could lead to SEP inertia
• Fed could announce a change to QT, although we don’t expect it

SEP watching

EXHIBIT #1: THE SEP COULD SURPRISE

^{Source: BNY Markets, Federal Reserve Bank Board of Governors}

There will be no rate move at Wednesday’s FOMC, but that doesn’t mean the March meeting will be absent of talking points. With economic doubts growing and policy uncertainty still extraordinarily high, the Fed will have an opportunity to weigh in on the outlook via a new quarterly Summary of Economic Projections (SEP). The “dots” will provide Committee members with a chance to express their individual and collective view on inflation, growth, unemployment, and, of course, policy rates.

Consumer confidence is ebbing and some economic variables weakening, but short-term inflation expectations are rising. We will see if – and how many – Committee members have changed their outlook since the December SEP.  If there are to be noteworthy changes in the dots, we would expect projections for 2025 inflation (seen at 2.5% in December) to be moved slightly higher, growth (2.1% in December) to be moved lower, and unemployment (4.3%) to rise. Policy rates are likely, in our view, to remain unchanged around 3.9%, implying two cuts this year.

Fed speakers continue to lament the high level of policy uncertainty and argue that it makes the outlook almost too murky to make clear assessments of the evolution of key economic variables and the appropriate policy response. Therefore, the dots might not change that much at all in magnitude, with at least some members of the committee preferring to stick with the December outlook, pending more certainty. We’re just not sure if that certainty will manifest itself any time soon, even with the new administration careening toward tariffs and potential retaliation.

Markets are currently pricing in approximately two cuts in 2025, with the first cut possibly coming as soon as June or July. Note how market-based expectations (see Exhibit #2) have moved their expectations lower since the last FOMC in January, with nearly one full additional cut taking place in H2 2025. Furthermore, the rate cut expectations increase for the second half of the year, not in the short term. From where we sit, this seems like a reasonable expectation for now and we don’t expect the dot for the federal funds rate to move materially in the SEP report.

To us – and probably to the Fed – the outlook remains uncertain and it’s too early to make a clear call on rates and economics. However, our bias is for weaker growth, higher unemployment and higher inflation. If this is what actually materializes over time, the Fed could eventually face a real dilemma, with higher prices and slower real activity. We have said in the past – and we don’t feel a need to alter this assertion – that if the short term inflation that comes is due to one-off price increases thanks to tariffs, the Fed would look through this development, as tariff-induced price changes are not a persistent inflationary process in the economy, but merely a policy shock (a tax hike on imported goods, to be exact) for which monetary policy is not suited. If this is the case but the economy weakens materially at the same time, we think there is more of a chance that the Fed will cut rates rather than raise them.

EXHIBIT #2: EXPECTING TWO CUTS THIS YEAR

^{Source: BNY Markets, Bloomberg}

Balance sheet policy to see a change?

In addition to the dots and the interest rate outlook, we will be watching for any mention of the balance sheet and QT policy at this meeting. In the minutes from the January FOMC, it was mentioned that debt ceiling dynamics could lead the Fed to slow, pause, or even cease quantitative tightening.

The argument is that while the debt ceiling remains in force, the Treasury will have to spend money from its general account rather than rely on bill sales to fund activities. This decline in the size of the TGA will show up as an increase in bank reserves, making liquidity conditions in the money markets appear quite flush. When the debt ceiling is ultimately resolved, the TGA will be replenished, potentially quite quickly, causing a drop in reserves that could be very sudden, exposing a lack of sufficient liquidity in funding markets. We have written about this a great deal, recently, including last week’s Short Thoughts (see here).

A few weeks ago, the manager of the New York Fed’s balance sheet program gave a speech in which he reiterated this risk, and again mentioned that a change of QT might need to be considered as long as the debt ceiling issue remained unresolved. These comments have led to speculation that there indeed could be an announced change to the QT program at this Wednesday’s FOMC.

We think it’s too early for such a move, although we acknowledge that the probabilities of such are not zero. However, we are not convinced that there has been enough advance work to prepare the markets for such a material change in balance sheet policy. This could change in the March FOMC statement, with language inserted to indicate that a change to QT is being contemplated and would happen if appropriate. If not explicitly mentioned in the statement, the question could be asked during the press conference.

We have been of the opinion that the Fed would wait until the debt ceiling is actually resolved before changing balance sheet policy, but we are cognizant that the longer the issue remains unresolved, the more the odds of such a change increase.