The case for keeping interest rates higher for longer is strong.
Amber Baesler/AP Photo
Markets expect multiple rate cuts from the Fed in 2024, but there’s still a case for them to remain high.
The economy is growing above trend, unemployment is low, and fresh inflation data came in hotter than expected.
Fed officials have said recently that inflation is still on the right trajectory.
At the end of last year, stocks were soaring, the labor market remained robust, consumers were still spending, and the “immaculate disinflation” narrative appeared fully intact. Rate cuts from the Federal Reserve seemed imminent, with some on Wall Street forecasting as many as six cuts beginning in March.
Yet Jerome Powell and his central bank colleagues have rebuffed those forecasts, and markets have pushed their rate cut predictions further into 2024.
This week’s economic data tempered optimism once more.
On Tuesday, January inflation clocked in at 3.1% year-over-year, above the expected 2.9%, according to the Bureau of Labor Statistics. Compared to the prior month, CPI climbed 0.3%, more than the forecasted 0.2%.
And the producer price index for January came in at 0.3% on Friday, higher than the expected 0.1% increase.
That data comes as stocks continue to notch all-time highs and cryptocurrencies are soaring like it’s 2021.
Nonfarm payrolls also surged in January, and unemployment is hovering near historic lows. US economic growth, too, continues to crush expectations, and Atlanta Fed researchers don’t anticipate a slowdown in GDP.
Meanwhile, the housing market has yet to soften. The price for a typical home in the US has climbed 47% since 2019, according to the S&P CoreLogic Case-Shiller National Home Price Index.
“The economy is healthy, price stability is within sight, but there is more work to do,” San Francisco Fed President Mary Daly said in a speech Friday. “To finish the job will take fortitude. We will need to resist the temptation to act quickly when patience is needed and be prepared to respond agilely as the economy evolves.”
To her point, one month ago markets gave 77% odds of a quarter-point March cut. That’s since plunged below 10%, per CME’s FedWatch Tool.
The case for higher for longer
Joe Seydl, a senior economist with JPMorgan Private Bank, told Business Insider he sees a 15% chance or less of another rate hike, yet cutting rates is “essentially optional” this year. He thinks the economy will likely keep growing regardless of policy adjustments.
“We wouldn’t expect the Fed to cut just because the markets expect it,” Seydl said. “They may push back against market pricing when they feel it is appropriate. If I had to speculate, I’d say the main reason they probably want to start cutting is that keeping rates too high for too long may start to distort investment activity in the economy, which could have long-run negative supply consequences.”
Jimmy Chang, the chief investment officer for Rockefeller Global Family Office, told Business Insider that it would be difficult for the Fed to cut rates in the current landscape.
“Based on all the data, it doesn’t really build a case for rate cuts,” Chang said, adding that even the pain in commercial real estate won’t warrant policy easing.
In his view, the Fed won’t make its move until unemployment climbs above 4% for several months in a row, which would signal the start of a recession.
“If the Fed eases prematurely, they run the risk of rekindling inflation pressure again down the road,” Chang said. “That’s the last thing the Fed wants, given how their credibility was hurt in 2021 and 2022.”
Uneven cooling
It’s possible that the cumulative effect of the Fed’s rate hiking cycle hasn’t been fully felt yet across the economy. The idea behind tighter monetary policy is to cool down inflation by reducing spending and growth, and based on the Fed’s own 2% CPI target, there’s still more work to do.
On Wednesday, Chicago Fed President Austan Goolsbee said inflation is still moving in the right direction, despite the latest uptick.
“We can still be on the path even if we have some increases and some ups and downs,” Goolsbee said in remarks at the Council on Foreign Relations.
Freedom Capital Markets chief global strategist Jay Woods took a similar stance: The economy is cooling, just not as quickly as many expected. He said a meaningful spike in CPI or PCE — the Fed’s preferred inflation gauge — could cement the higher-for-longer argument, but so far that’s not happened.
“We’re still in the soft landing camp,” Woods told Business Insider. “Things may not be as smooth as people think, but even the thought of another rate hike would require an extreme shock to the system.”
The Fed’s next move
The case for keeping rates unchanged has gained momentum over recent weeks, but both markets and the Fed ultimately expect easing interest rates in 2024. CME projections and policymakers’ own dot plot projections say as much.
Powell has proved reliable and transparent in recent months about the central bank’s outlook, and markets have responded with strong stock rallies.
The blowout January jobs report and hot CPI reading have fueled concerns of an overheating economy, but the retail sales data released Thursday pushed back on that thinking. January data came in softer than expected, dipping 0.8% month-on-month, versus the expected 0.3% decline.
The reading implies the resilient consumer is beginning to crack, but markets largely shrugged it off. One confounding detail in the release was that spending on food and drink actually climbed 0.7% compared to December, which hardly looks recessionary.
“We caution against over-reacting to this, just as we cautioned against the idea that the jobs and inflation data were a game-changer,” Bank of America analysts wrote in a note Thursday. “The January data have been noisy. Tuning out the noise, we remain comfortable with our narrative of a benign slowdown in economic activity, with risk to our baseline forecasts still skewed slightly to the upside.”
Bank of America forecasts that the first cut likely won’t happen until June, and policymakers could opt to cut rates “later and faster.”
Woods, for one, expects a quarter-point cut.
“The Fed has the wiggle room to cut at least once,” he said. “I don’t anticipate inflationary pressures to rise dramatically, I do think unemployment will tick higher, and that should give them the ability to cut and not be questioned.”