What does it mean when the Federal Reserve says it’s going to pivot its monetary policy?
The short answer is that a pivot occurs when the underlying economy has shifted so much that the Fed believes it’s forced to change its outlook.
In today’s economic cycle, this means that the Fed has started to talk about cutting short-term interest rates after a period of higher rates. As many of you may recall, the Fed started to increase short-term rates in early 2022 in an attempt to rein in inflation. However, by late 2023, the Fed has signaled it’s prepared to pivot, and outlined a plan to lower rates in an attempt to boost overall economic activity.1,2
The Fed’s Role in the Economy
To better understand what drives the Fed to pivot, it helps to understand the Fed’s many jobs and the tools at its disposal.
“Spend time with the wise and you will become wise, but the friend of fools will suffer.” Proverbs 13:20
The Federal Reserve has four main jobs, which consists of overseeing the nation’s monetary policy, supervising the banking system, maintaining financial stability for the country, and providing guidelines for how banking payments are made.3
In determining whether an interest rate pivot is needed, the Fed looks to manage price stability (inflation) while pursuing maximum employment. In December 2023, when Fed Chair Powell indicated that interest rate cuts were possible, he was suggesting that he was comfortable with the existing monetary policy because of the trends in both inflation and employment.4
Goldilocks Economy
When the Fed started to raise interest rates, you may have heard the expression “soft landing.” This happens when the Fed raises interest rates and brings down inflation without causing a recession (unemployment tends to increase during a recession). Some refer to a soft landing as a Goldilocks economy as it is not too hot and not too cold.
It appears that the Fed is more comfortable with how it has pursued the goals of managing inflation by slowing the economy. Q4 2023 gross domestic product was strong and the Atlanta Federal Reserve’s GDPNow forecasting model is showing a solid Q1 2024 estimate despite the federal funds rate reaching its highest level since 2007.5
Managing the Cycle
The Fed is looking to guide the economy toward a soft landing in 2024, which will mean moving through the “trough” phase of the business cycle without pushing the economy into a recession.
The Fed’s Toolbelt
To steer monetary policy, the Federal Reserve’s main tool is the federal funds rate, which is usually expressed as a target range rather than an actual percentage. Fed funds refer to the interest rate banks charge each other when borrowing money. By moving fed funds lower, the Federal Reserve guides financial institutions to lower interest rates throughout the economy, which is designed to boost overall economic activity.
In recent years, you may also have heard the term “quantitative easing.” This refers to the process through which the Federal Reserve works with banks to add more money to the overall economy. When interest rates are near zero, and economic activity has stalled, the Fed can turn to what’s called “QE” strategies. However, when interest rates are higher, the Fed typically does most of its work through fed funds.6
The Federal Reserve has made it clear that interest rates are heading lower, but it’s not saying when it will act. During these transitory periods, it’s best to keep focused on your overall financial goals but to also remain prepared to discuss changes when interest rates begin to trend lower.
- Investopedia.com, February 25, 2023
- Forbes.com, March 15, 2023
- Federalreserve.gov, 2024
- CNBC.com, December 2023
- Atlantafed.org, March 11, 2024
- Bankrate.com, March 7, 2022
