Expanding on My Featured LinkedIn Post: The Fed’s QT Soft Pivot

Last week, I was honoured to have my LinkedIn post featured by LinkedIn News, where I discussed the Fed’s evolving stance on Quantitative Tightening (QT). You can check out my original post here: LinkedIn Post and the related LinkedIn News feature: Fed Not Ready to Budge on Rates. Since then, I’ve taken a deeper dive into what the Fed’s latest moves mean for inflation, markets, and potential policy shifts in 2025.

The January 28/29 meeting minutes signalled a subtle but important shift in the Fed's approach. While the Fed didn’t outright mention Quantitative Easing (QE), the minutes suggest a growing willingness to slow down QT, ensuring financial markets remain liquid. The key takeaway? While the Fed isn’t making drastic moves yet, it’s keeping the door open for a more accommodative stance later this year… and as traders, if we know one thing, the market is always forward looking!

Breaking Down the Fed’s Meeting Minutes

One of the biggest developments was the discussion around slowing balance sheet reduction. Some Fed officials raised concerns about draining too much liquidity from the system, hinting at the possibility of pausing or adjusting the runoff of assets. Since June 2024, the Fed has aggressively reduced its securities holdings, but with market stability in mind, it may now slow the process. This isn’t quite QE, but it does signal a shift away from aggressive tightening.

Another key focus was on reserve levels, with discussions about maintaining a possible $3 trillion floor for bank reserves. This underscores the Fed’s intent to prevent any financial instability by ensuring ample liquidity. If reserves shrink too much, the Fed may slow QT to stabilize markets.

Additionally, the Fed reiterated its policy flexibility, emphasising a data driven approach. Officials left room for potential rate cuts or balance sheet adjustments if economic conditions warranted them. This means the Fed is carefully balancing the risks of inflation against potential economic slowdowns.

What This Means for Markets

Last week was a rollercoaster for risk markets, with Friday marking a very sharp downturn, particularly for the Nasdaq-100 (NQ), which fell over 2.5%, erasing a significant portion of its prior gains. This sell-off wasn’t just a random dip; it was fueled by a confluence of factors, including rising inflation concerns, shifting Fed expectations, technical market weaknesses, and geopolitical risks. Earlier in the week, we had all been optimistic about a potential policy pivot following signals from the Fed’s recent meeting minutes, but as markets often do, they recalibrated their outlook as new risks emerged.

Initially, we saw the market welcomed the Fed’s subtle shift in tone, interpreting it as a sign that policymakers might ease conditions sooner if financial stress emerged. This optimism fueled a rally in risk assets, particularly equities and cryptocurrencies, as investors anticipated looser monetary conditions that could provide a tailwind for markets to perform very well over the coming months. However, as the focus shifted back to inflation and the Fed’s hesitancy to commit to near-term rate cuts, uncertainty crept back in, culminating in Friday’s sharp sell-off across risk assets.

The NQ decline was not isolated, it sent ripples across broader markets, with the S&P 500 and Russell 2000 also posting losses, while the CBOE Volatility Index (VIX) surged over 20%, reflecting heightened uncertainty. Cryptocurrencies, while still maintaining a high time frame bullish structure, mirrored the downturn, with Bitcoin and Ethereum experiencing range bound declines as investors moved away from high risk assets. Meanwhile, traditional safe havens like bonds and gold held steady, signalling a shift toward a more cautious risk-off sentiment. The underlying driver of this repricing was growing concern that inflation might remain more persistent than expected, potentially delaying the Fed’s timeline for easing monetary policy.

Looking ahead, all eyes remain on inflation, which continues to be the dominant force shaping expectations for Fed policy. But beyond inflation, investors are also monitoring several key catalysts that could influence market volatility, including upcoming economic data releases, geopolitical developments, and major corporate earnings reports. With Nvidia’s earnings on the horizon this week and a packed economic calendar (PCE inflation on Friday), the next few weeks will be critical in determining whether last week’s sell-off was a temporary shakeout or the start of a broader shift in sentiment.

Inflation Outlook

Inflation remains a critical wildcard in the Fed’s decision making process, with recent projections highlighting a potential disconnect between market expectations and the Fed’s own outlook. Bank of America recently revised its U.S. CPI inflation forecast to 4.6% by July 2025, a sharp contrast to the Fed’s December 2024 projection of 2.4%, ultimately raising concerns that policymakers may be underestimating inflation’s persistence. If this trend continues, year-over-year inflation could form a brutal second hump. Even if monthly inflation prints ease to 0.3%, year-over-year inflation would still climb to 3.8%, reinforcing the challenge the Fed faces in bringing inflation under control.

Several factors continue to pose upside risks to inflation. Geopolitical tensions, particularly the Israel-Iran conflict, could disrupt global oil markets, driving energy costs higher. Supply chain issues remain a lingering threat, while tighter immigration policies could restrict labour supply, exacerbating wage pressures. Meanwhile, market based measures such as Treasury Inflation Protected Securities (TIPS) indicate that investors anticipate inflation staying above the Fed’s 2% target, with 5-year breakeven rates hovering around 2.3%–2.5%.

As inflation expectations remain elevated, the Fed faces a delicate balancing act, tightening too much risks economic slowdown, while easing prematurely could entrench inflation further. The coming months will be pivotal in determining whether inflation moderates or forces the Fed to maintain a more restrictive stance for longer.

When Will the Fed Pivot?

Risk Markets are eager for rate cuts, but the Fed has made it clear that patience remains its guiding principle. In its January 2025 meeting, the Fed held rates steady at 4.25%–4.50%, with Chair Powell reinforcing on February 21 that they are "not in a rush to cut rates."

Despite hopes for a shift in policy, market expectations have adjusted accordingly. According to FedWatch, the market is currently pricing in just a 2.5% probability of a rate cut in March 2025 (as can be seen in the images below), with markets now projecting the earliest cut to arrive in June 2025 or later. In fact, Goldman Sachs has warned that if inflation remains stubbornly high, the Fed may delay cuts until late 2025.

Many investors are closely watching upcoming economic data releases, as they are likely to fill the missing pieces of the puzzle and play a decisive role in the Fed’s next moves. Key reports, including January New Home Sales (Feb 26), Q4 2024 GDP (Feb 27), and January PCE Inflation (Feb 28).

Final thoughts

Inflation expectations remain elevated, and while the Fed is signalling a more flexible stance, it’s clear they’re not ready to pivot just yet. The next major policy moves will depend on upcoming inflation data and economic indicators in the coming weeks.

If inflation cools, rate cuts could arrive sooner rather than later. But if price pressures remain strong, the Fed might hold steady for longer than markets expect.

Key takeaways:

1. The Fed Hints at Slowing QT, But No Pivot Yet: The Fed is open to slowing Quantitative Tightening (QT) to maintain liquidity, but Quantitative Easing (QE) is not on the table yet.

2. Market Volatility Reflects Inflation and Fed Uncertainty: Initial optimism over a Fed pivot faded as inflation fears resurfaced, leading to a Nasdaq-100 sell-off (-2%) and a shift toward safe-haven assets like gold and bonds.

3. Inflation Risks Remain Elevated: Bank of America sees inflation hitting 4.6% by July 2025, well above the Fed’s 2.4% target, with risks from geopolitical tensions, supply chains, and labour shortages.

4. The Fed is in No Rush to Cut Rates: Markets expect cuts by mid-2025, but the Fed remains cautious, and Goldman Sachs warns cuts could be delayed if inflation persists.

5. Key Data Releases Will Shape Fed Policy: Upcoming PCE inflation (Feb 28), GDP (Feb 27), and housing data (Feb 26) will be crucial in determining when (or if) the Fed pivots.

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