Evening Brief – 02.26.24

Delayed, Not Canceled

While inflation data remains sticky, market expectations for the Federal Reserve to start cutting interest rates have been delayed rather than canceled. Some analysts are pushing back on the idea of an imminent rate cut, with forecasts suggesting that the FOMC may leave rates higher for a more extended period.

However, based on implied market projections, the central bank remains on pace to cut rates this year. Market expectations, as reflected in Fed funds futures, anticipate the possibility of the first interest rate cut at the June 12 FOMC meeting, with a 77% probability of a cut.

The Treasury market also continues to price in interest rate cuts based on the policy-sensitive U.S. 2-year yield. On Monday, the yield was trading at 4.71%, well below the Fed’s current target rate of 5.25%-5.50%.

The market has expected a rate cut for over a year, based on the 2-year yield, yet the implied forecast must play out as anticipated.

Monetary policy is tight; therefore, interest rate cuts are likely appropriate at this juncture. Several policy guidelines assessed by the Cleveland Fed show a similar pattern. The simplest version of the so-called Taylor rule, for example, argues that the current federal funds rate should be significantly lower.

Former US Treasury Secretary Larry Summers recently stated that there is a 15% probability that the Federal Reserve would continue to hike interest rates to control inflation, which has slowed recently but gradually, prompting concerns that disinflation has paused. “There’s a meaningful chance, maybe it’s 15%, that the next move is going to be upwards in rates, not downwards,” he told Bloomberg Television. “The Fed is going to have to be very careful.”

Atlanta Fed President Raphael Bostic, a current voting member of the Fed, recently said that “we’ve seen a lot of progress in terms of inflation,” but that the trajectory will be a “little bumpy” through 2024. For the time being, he still expects a cut in rates in the “summertime,” he told CNBC, and he presently sees two cuts in 2024, which is fewer than the estimate predicted by Fed funds futures.

The next major test on expectations will come Thursday, with the release of PCE Price Index data for January.