Shrinkage of the Balance Sheet and Interest Rate Forecasts

If the Federal Reserve (Fed) slows the shrinkage of its balance sheet, the rate of change in mortgage rates should also slow.
The Fed was concerned that the housing market might weaken excessively with mortgage rates rising too high (e.g., 7%). Their objective was to keep rates in the 6% range.

The Fed considered having two or three meetings on a particular matter, an uncommon occurrence.
The meeting on May 6 resulted in the decision to hold rates steady and not to continue shrinking the balance sheet.
The Fed acknowledged that tariffs are likely to cause a one-time increase in the price level but emphasized their commitment to keeping long-term inflation expectations anchored.
The Fed's stance was described as comfortable and characterized by a "wait and see" approach to allow for greater clarity on economic developments.

The Federal Open Market Committee (FOMC) issues a quarterly forecast on interest rates called the "dot plot."
The dot plot provides insights into where committee members expect interest rates to be in the future.
For 2025, some committee members (four dots) believed that interest rates would remain at the current level of 4.25% to 4.5% year-end.
A significant number anticipated rates to be in the 3.75% to 4% range. Adding all the dots and averaging indicates a year-end rate of 4%.
For the following year, the speaker suggested a rate of 3.45%.

The long-run interest rate is often referred to as "r-star" ( $r^<em>$ , or $r^</em>$ ).
"R-star" represents the Goldilocks interest rate: neither too high (constricting the economy) nor too low (artificially expanding the economy).
Another term for r-star is the "neutral" interest rate.
Looking ahead to 2026, some participants (three people) projected interest rates below 3%, while others (three people) expected them to remain above 4%, indicating uncertainty among committee members.
The speaker indicates there are multiple cuts for interest rates as follows: Four members see one cut. Nine members see two cuts. Two members see three cuts.

The speaker speculated about the possibility of returning to near-zero interest rates, similar to the periods of 2006-2008 and 2008-2016, as well as during the COVID-19 pandemic.
The speaker noted how projections changed after events like Trump's election and the implementation of tariffs, suggesting that future projections could change based on tariff developments.

The Fed Funds Futures market can be used to gauge the probability of future interest rate changes.
The market indicated a high probability (95.5%) that rates would remain unchanged at a specific meeting, and this prediction turned out to be accurate.
There was a small percentage (almost 10%) of bettors who anticipated lower rates, reflecting concerns about potentially higher unemployment.

Tariffs could lead to both higher inflation and slower economic growth.
If tariffs cause higher unemployment, the Fed might lower rates to stimulate job growth.
A small percentage of investors (8.4%) were betting on the Fed lowering rates, suggesting they were more concerned about the potential impact of tariffs on employment.

The current members of the Federal Reserve Board of Governors were presented, including the first Hispanic woman to serve, who stated their commitment to achieving the 2% inflation mandate.
Ralph Hale Bostik, Atlanta Fed president, adjusted his forecast to only one interest rate cut this year instead of two due to new bond pricing.

The treasury spread may not be as reliable in predicting recessions as it once was.
The speaker planned to discuss alternative methods for predicting economic trends.
The consumer price index (CPI) is an important indicator. Core inflation is calculated by excluding food and energy prices from the CPI, as these are considered volatile and subject to external factors like weather.

Market participants can bet on whether the Fed will change rates (raise, lower, or hold steady).
At the time, there was zero probability assigned to the Fed raising rates, suggesting a prevailing belief that inflation would not be a major concern.
If tariffs were to cause higher prices, the expectation would be to raise rates. However, if tariffs were to cause more unemployment, the expectation would be to lower rates to fix it.
A minority (8.4%) believed that the Fed would lower rates due to the potential for tariffs to cause job losses.

The two main potential impacts of tariffs are higher inflation and slower economic growth. Market analysts have different expectations as to which outcome is more likely.