Federal Reserve Meeting Preview: Strong Data is Making it Hard to Justify Cutting Rates
Author: Daniela Hathorn
Date: 30 January 2024
Overview
The upcoming Federal Reserve meeting is anticipated to result in unchanged interest rates, with a 98% probability of maintaining the current range of 5.25% - 5.50%. This decision comes despite recent economic data indicating a drop in the core PCE index to 2.9%, the lowest since March 2021. In contrast, the Consumer Price Index (CPI) saw a slight increase to 3.4% in December, complicating the disinflation process as it approaches the Fed's 2% target.
Economic Context
The latest GDP figures reveal a robust growth of 3.3% in Q4 2023, following a remarkable 4.9% in Q3. This performance highlights the resilience of the US economy compared to the UK and Eurozone, where economic conditions are less favorable. The article questions whether the Fed, led by Jerome Powell, should consider rate cuts in light of this strong economic backdrop.
Comparative Analysis with Other Central Banks
The European Central Bank (ECB) recently opted to keep rates unchanged, with President Christine Lagarde providing no timeline for potential cuts. This raises the question of why the Fed would consider cuts when the ECB has not. Although US rates are higher, the overall economic health suggests a different approach may be warranted.
Challenges in Rate Cut Justification
Despite some dovish signals from Powell in December, the Fed's dual mandate of managing inflation and employment complicates the decision-making process. The labor market remains tight, and Powell has previously indicated that a weakening job market would be necessary before considering rate cuts. The article discusses various methods to measure real rates, which could influence the Fed's stance.
Market Implications
The resilience of the stock market poses risks for the Fed if they decide to cut rates, as rising asset prices can contribute to inflation. Geopolitical risks and fluctuating energy prices also add complexity to the Fed's balancing act between fostering growth and controlling inflation.
Future Expectations
Market participants are eager for forward guidance from the Fed regarding future rate cuts. Current expectations suggest that the first 25 basis point cut may not occur until the second half of 2024, with a 50% chance of a cut in March being viewed as overly optimistic. By December, markets anticipate a 35% chance of rates falling to between 3.75% and 4%, indicating a potential for significant repricing in the coming months.
Conclusion
The article concludes that the Fed's communication in the upcoming meeting will be crucial. A focus on strong economic data could strengthen the US dollar and yields while negatively impacting equities. Conversely, continued dovish messaging may support equity markets but could reverse the dollar's recent gains.