By Michael S. Derby
NEW YORK Federal Reserve forecasts released at the June monetary policy meeting laid out an outlook that was more hawkish than what Wall Street’s biggest banks had penciled in ahead of the gathering.
According to the June survey of primary dealers, who underwrite Treasury debt auctions, the banks forecast a 5.38% stopping point for the federal funds target rate range, which is lower than the 5.6% that Fed officials ended up penciling in at the gathering. The Fed’s outlook implies another half percentage point increase from the current target of between 5% and 5.25%, which the Fed held steady at the Federal Open Market Committee meeting held on June 13-14.
The primary dealer survey was released on Thursday by the New York Fed and was joined by the survey of market participants, most of whom are large money managers. Respondents to that poll were also caught off guard by the Fed outlook and had projected the same Fed stopping point as the primary dealers. Both surveys were done ahead of the FOMC meeting.
The primary dealers expect a full percentage point's worth of rate cuts in 2024, starting in the first quarter of that year, while the market participant survey sees a move down to 4.25%. At the Fed meeting, officials eyed a 4.6% funds rate by the end of next year.
The dealers were also polled on their expectations for the drawdown of the Fed’s balance sheet. The Fed has been allowing just under $100 billion per month in Treasury and mortgage debt to mature and not be replaced, complementing a rate rise campaigns that began in March 2022, when short-term rates were at near zero levels.
Fed officials have given little guidance about when the central bank would stop the drawdown. The pre-FOMC survey of dealers projected the Fed would stop shedding Treasuries in the second quarter of 2024 but will continue unloading mortgage debt at least into the fourth quarter of 2025, which is as far as the survey sought answers.
Dealers in the survey offered a range of views as to why the balance sheet drawdown would stop. Some said it would accompany the start of rate cuts, while others said it would stop when Fed officials determined a recession was likely.
Speaking Thursday, Lorie Logan, who managed the Fed’s holdings of cash and securities before becoming the Dallas Fed president last year, said the view shown in past surveys pointing to an end of the drawdown in the second quarter of next year 'surprised me."
Logan, at an event at Columbia University, said it was likely wrong to think the drawdown would stop just because the Fed was lowering rates. She explained the Fed could be lowering rates simply because inflation was coming down and it was trying to balance monetary policy to that shift.
Logan said in her view, the Fed has a long way to go reducing its holdings.
The dealer and market surveys also offered projections about the size of the Fed’s reverse repo facility. This tool exists to put a floor underneath short-term rates and has seen very high usage by those eligible to use it. Mainly used by money funds, this tool finally saw inflows fall below $2 trillion per day last month, and they are widely expected to fall further as private market rates become more attractive and the Treasury ramps up issuance.
Primary dealers reckon the daily reverse repo inflow will hit $1.119 trillion by the fourth quarter of 2024.
(Reporting by Michael S. Derby; Editing by Andrea Ricci)
