The Big Picture
It is time to take a walk down Memory Lane. It won't be a long walk. We are only going back to April 2023. That was when the fed funds futures market was pricing in three rate cuts before the end of 2023.
For the record, the Fed didn't cut rates three times before the end of 2023. In fact, the Fed didn't cut rates at all.
Let's now travel to the future. The fed funds futures market thinks the Fed will cut rates five times before the end of 2024 (although it is a close call for as many as six rate cuts), according to the CME FedWatch Tool.
- Probability of 25 basis points rate cut to 5.00-5.25% at March FOMC meeting is 47.4% versus 83.3% a month ago
- Probability of 25 basis points rate cut to 5.00-5.25% at May FOMC meeting is 87.6% versus 99.7% a month ago
- Probability of 25 basis points rate cut to 4.75-5.00% at June FOMC meeting is 87.0% versus 97.8% a month ago
- Probability of 25 basis points rate cut to 4.50-4.75% at July FOMC meeting is 80.2% versus 98.0% a month ago
- Probability of 25 basis points rate cut to 4.25-4.50% at September FOMC meeting is 75.9% versus 95.7% a month ago
- Probability of 25 basis points rate cut to 4.00-4.25% at November FOMC meeting is 55.5% versus 85.4% a month ago
- Probability of 25 basis points rate cut to 3.75-4.00% at December FOMC meeting is 47.6% versus 77.9% a month ago
We would concur that the Fed is likely to cut rates in 2024, but five to six rate cuts is ambitious for a Fed that is fearful of making the same mistake the Fed did in the 1970s when it started to cut rates only to see inflation flare up again.
Under Control
The Fed was speedy with its rate hikes starting in March 2022. It had to be, because it waited far too long to raise rates and let inflation get out of control.
To the Fed's credit, it has gotten inflation under control (but not total control) with some help from easing supply chain pressures. You can see that in the inflation numbers.
We just don't think -- and we don't think the Fed will think -- it has inflation in a strong enough chokehold to allow for five to six rate cuts by the end of 2024. The Fed's own projections call for three rate cuts, but to be fair, the December core PCE Price Index could move the needle on the Fed's thinking.
The problem is that we won't have anything codified in that respect until the next Summary of Economic Projections (SEP) is released in March. However, if the last SEP is any indication, the Fed should be sticking with an outlook for at least three rate cuts by the end of 2024.
Why do we think that?
The Fed's median estimate for core-PCE inflation for 2023 was 3.2%. We learned in the December Personal Income and Spending Report that the core-PCE Price Index ended 2023 up 2.9% year-over-year -- the lowest since March 2021. However, the six-month annualized rate was just 1.9%.
New Voters
Fed officials haven't avoided the topic of rate cuts. Some have volunteered that they think the Fed can cut rates, but most have conceded that they can proceed carefully with that effort.
Importantly, none of the new voting Fed presidents on the 2024 FOMC have signaled that a rate cut is imminent. Those presidents are Raphael Bostic (Atlanta), Loretta Mester (Cleveland), Thomas Barkin (Richmond), and Mary Daly (San Francisco).
Ms. Daly, viewed by many to be more dovish minded, said last week that it is premature to think a rate cut is around the corner. There won't be a rate cut at the January 30-31 FOMC meeting, but from our vantage point, March 19-20, which is the date of the next FOMC meeting, is right around the corner.
The fed funds futures market has been walking back its March rate-cut expectations. A month ago, it priced in an 83.3% probability of a rate cut at the March meeting, according to the CME FedWatch Tool. Today, that probability is 47.4%, so it is close to a coin toss in the market's mind.
It's one thing for core PCE to be moving back toward 2.0%, but it's still another thing to think that it is going to get there and stay there on a sustained basis. The latter condition is key to the Fed's policy view, which is why its patience may prove to be a frustrating virtue for the market.
What It All Means
The Fed made the mistake of waiting too long to raise rates, and it knows it. That understanding should factor heavily in its thinking that it should take a more deliberate approach to cutting rates.
We would argue, too, that the Fed is taking notice of the easing in financial conditions, manifested clearly in lower rates and a stock market trading at record highs, and will be concerned that it risks compounding an easing in financial conditions that could delay efforts to get inflation down to the 2.0% target on a sustainable basis.
That doesn't mean the Fed wants the stock market to sell off, only that it is going to be pre-occupied with wanting to see more inflation data in coming months before it commits to the first rate cut, confident inflation can stay down even if the stock market keeps going up.
That deliberate approach is apt to undermine the market's more generous rate-cut expectations. Nonetheless, the prospect of a rate cut, or several rate cuts, before the end of 2024 looks more practical than it did in April 2023 when core-PCE inflation was running at 4.8% year-over-year, assuming of course inflation continues on its current glide path.
