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The first Federal Open Market Committee (FOMC) meeting of 2024 is behind us and the markets no longer seem convinced that we will see an interest rate cut the next time the 12 committee members meet in March. Some 34% of the market expect a rate cut at the next meeting, down from 73% just one month ago. Indeed, I do not expect the Federal Reserve to start cutting rates until the end of the second quarter–at the earliest.
The economic data suggests there is currently very little justification for a rate cut come March. Inflation came in higher than expected in December, the labor market remains as tight as a drum, and retail sales rose more than projected last month. Granted, much of this was driven by the festive season, and the annual January blues will almost certainly drive inflation and spending lower. However, this will likely be a short hiatus before a rebound later in the quarter. Overall, the economy is still running hot, and it is economic data that drives the FOMC’s monetary policy decisions.
Sticky core inflation will keep the Fed on its toes
Inflation in December surprised the market with a rise from 3.1% to 3.4%, while core inflation–the Fed’s preferred measure–rose 0.3% month-over-month (MoM) and 3.9% year-over-year (YoY). Our data reveals that over recent months, inflationary pressures have come primarily from the services sector, though December also saw an uptick in luxury goods purchases.
In turn, services inflation has been exacerbated by the tight labor market. Despite some talk of a softening of labor conditions, December’s unemployment rate remained ultra-low at 3.7%. Initial jobless claims have averaged just under 210,000 in recent weeks–well below historical averages. Indeed, we have not seen a single monthly decline in jobs since 2020.
At the same time, wage growth has sped up again, hitting a rate of 6.5% YoY in November, up from 5.7% in October, driven in part by pressure from unions. Higher wages, combined with spending on credit and stronger consumer sentiment, have fuelled consumer spending. U.S. retail sales beat analysts’ expectations in December with a rise of 0.6% MoM and 5.6% YoY.
A more hawkish FOMC
Against this economic backdrop, the market seems to have misinterpreted the signals from Fed Chairman Jerome Powell. Though the Chairman said a discussion of rate cuts is coming “into view”, he has also been consistently clear that his primary objective remains the 2% inflation target–even at the expense of an economic slowdown. There is nothing in today’s meeting that would suggest he has had a change of heart.
Indeed, Powell’s rhetoric throughout most of 2023 was more hawkish than the market gave him credit for, though we have seen his position soften over the last two months. Yet with core inflation at nearly double the Central Bank’s target, there is little reason to believe we will see a cut this quarter.
If anything, this year’s changing of the guard at the FOMC may lead to an even more hawkish stance. Only one of the four incoming members (San Francisco Fed president Mary Daly) has publicly called for a discussion on rate cuts. Richmond Fed president Tom Barkin wants to see further falls in inflation, Atlanta’s Raphael Bostic predicts cuts in the second half of the year, and Cleveland’s Loretta Mester says the market’s expectations have got “a little bit ahead” of the Fed–a diplomatic understatement if ever we’ve heard one.
It will also be interesting to see whether the committee can maintain the same level of cohesion in its decisions in 2024. After all, this year’s monetary policy calls are likely to be more contentious than what we saw in 2023. A more divided FOMC could also delay any interest rate cuts.
A delicate balance
After a tough 2023, a victory in the Fed’s battle against inflation is now within reach. However, with the economy running hot and an uncertain macroeconomic climate, it is more difficult to predict the course of inflation than it was last year. Several factors, including growing geopolitical unrest, could push inflation higher. However, the effects of monetary tightening also take time to come through, so we may soon begin to see an economic slowdown. As such, balancing its dual mandate will be no easy feat for the Fed this year.
While the economy remains strong and the threat of sticky inflation lingers, the Fed will likely continue to take a cautious stance on interest rates until the murky backdrop becomes clearer. Even when core inflation finally recedes towards the 2% target, we do not foresee the aggressive cutting cycle that many pundits were forecasting. Higher-for-longer rates are here to stay–and it’s time for the market to accept this new paradigm.
Oliver Rust is the head of product at independent data aggregator Truflation.
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