What has changed since January
Progress on inflation since its peak in mid-2022 is undeniable.
Whether measured in terms of PCE or CPI, figures have come down by around two-thirds. This is partly due to global trends such as the easing of supply chains, but also the rapid and decisive action the Fed has taken by increasing the funds rate to its current level of 5.25% to 5.5%.
As of the start of the year, markets were looking forward to a steady easing in monetary policy. The Fed itself had forecast three cuts for the year, and there was hope in some quarters that these cuts could begin as early as March. Overall, it was forecast that rates would fall as low as 4% by the end of the year.[1]
In February, however, both the PCE and CPI measures of inflation ticked upwards and away from the 2% target.[2] The minutes of the Federal Reserve’s March meeting show officials were concerned by this apparent stalling of progress. Some appear to have questioned if the rate had been raised high enough.[3]
“If you get another month that looks like January or February,” commented committee member Thomas Barkin, “That takes you in a very different direction in terms of how forward-leaning you are.”[4] Two of his colleagues went so far as to question the need to cut rates at all in 2024.[5]
The latest numbers
On April 10, the March figures for CPI inflation were released, showing a year-on-year increase of 3.5%. This is not only higher than in February (3.2%) but the highest increase in six months. The Core CPI, which omits more volatile items, remained at 3.8%.[6]
This came in addition to the official job figures, which showed that the labor market (a key driver of inflation via wage increases) continued to accelerate in March. Unemployment declined from 3.9% in February to 3.8%, while average hourly earnings increased 4.1% year-on-year.[7]
While the PCE inflation figures for March have yet to be announced, economists expect a monthly increase of 0.3% in Core PCE, in line with a similar increase in February.[8] And it is possible that these figures too could come in higher than expected when they are released on April 26th.
While markets had been able to shrug off the previous months’ lukewarm data as inconclusive, the latest figures have made the situation hard to deny. Progress has stalled.
The implications for the Fed
For now, the Fed has maintained its forecast of three rate cuts in 2024, but the window for such activities is closing. The upcoming party conferences in the summer, not to mention the general election in November, make the situation even more delicate.
Politics aside, with no obvious recession looming, there is less incentive to cut rates for economic reasons. If anything, the fear is that the Fed in doing so might repeat its error from the 1960s and cut rates too early, ushering in a decade or more of entrenched inflation.[9]
JP Morgan Chase’s CEO, Jamie Dimon, went so far as to warn his shareholders in a recent letter that both rates and inflation could remain higher, and for longer, than market expectations. He added that the bank is prepared for ‘a very broad range of interest rates, from 2 percent to 8 percent or even more’.[10]
Chairman Powell himself all but confirmed the Fed’s stance has changed since earlier this year, stating on April 16th that it would likely ‘take longer than expected’ to achieve the confidence needed to start cutting rates.[11] As of the time of writing, the market is pricing in the first cut for as late as September, with only two cuts expected overall this year.[12]
Conclusion
So far as the short-term is concerned, President Joe Biden gave perhaps the wisest response when asked about the Fed’s likely next move, when he responded, “I’m not sure of that. We don’t know what the Fed is going to do for certain.”
Short-term uncertainty is only a problem for those with a short-term investing mindset. We always recommend our clients take a long-term view wherever possible. As you’ll see below, the current situation looks very different if one looks back five decades, compared with looking only at the last decade.
Source: St. Louis Federal Reserve (https://fred.stlouisfed.org/series/DFF) or Trading Economics (https://tradingeconomics.com/united-states/interest-rate).
It is entirely possible that we could, as Jamie Dimon has suggested, be entering a new era. We explore the implications of this in our recent white paper Shifting Balance. As we outline in that report, a long-term perspective makes it easier to plan for an uncertain future, if you have the right strategy, toolset, and team to support you.
[1] New York Times
[2] St. Louis Federal Reserve
[3] U.S. Federal Reserve
[4] Reuters
[5] Financial Times
[6] Bureau of Labor Statistics
[7] Bureau of Labor Statistics
[8] Reuters
[9] CNBC
[10] JP Morgan Chase
[11] The Guardian
[12] CME FedWatch Tool