An Unsynchronized Global Rate-Cutting Cycle 

Following a synchronized approach over the past two years to increase interest rates to manage rapidly rising inflation, major central banks are now differing in their strategies for when and how to loosen monetary policy. 

The European Central Bank (ECB) and Bank of Canada both cut interest rates by a quarter point last week. The central banks of Switzerland, Sweden, and the Czech Republic have already followed suit. 

The start of a policy easing cycle has these central banks at odds with the Federal Reserve, which on Wednesday held the federal funds target range steady at 5.25% to 5.50%, as widely expected and where it has stood since last July. 

“We are at the beginning of a new regime in central banks, as many major central banks start to ease policy ahead of a very timid Fed,” James Rossiter, head of global macro strategy at TD Securities, wrote in a note. 

Furthermore, the Fed released predictions indicating greater reluctance than previously to begin cutting rates. The central bank’s “dot-plots” were considered hawkish, adjusted to just one quarter-point rate cut in 2024 from three cuts in the previous “dot-plot” forecasts in March, and four quarter-point rate cuts in 2025 compared with three cuts previously. 

There was also another notable development. The longer-run estimate of the federal funds rate rose to 2.8% in the median forecast, which is the second straight increase following a rise to 2.6% from 2.5%. 

The positive development is that although growth surprises have dropped, so have inflation surprises following four months of stagflationary signals. 

Sticky Inflation 

Sticky inflation, however, is still the crowd’s outlook. That leaves the question of how the Fed will react. “The reality is that inflation is very sticky and the FOMC seems to be increasingly aware of this,” Michael Underhill, CIO of Capital innovations, told Connect Money. 

Powell laid out two “tests” for starting interest rate cuts during his press conference on Wednesday. The Fed either gains greater assurance that inflation is moving steadily toward the central bank’s 2% target, or there is an “unexpected deterioration” in labor market conditions.   

Underhill agreed with Powell’s latter test. “I believe that a deterioration in the labor market is the most likely route to rate cuts.”  

“We do not share the Fed’s optimism that they can rebalance labor demand and supply this year without raising unemployment. Therefore, we still expect two cuts this year, in September and December.” 

Time Will Tell 

When the Fed will begin to take a more accommodative stance remains to be seen, but investors have not completely given up expectations for an early start to the easing cycle. 

The policy-sensitive 2-year Treasury yield, which is trading around 4.69% and at its lowest level in two months, continues to trade well below the current federal funds target range. Moreover, over the past two days the spread has widened, implying higher odds of an interest rate cut. 

The latest rate cut expectations are interesting. While forecasts have moved higher for all remaining meetings – September remains the most likely time for the first quarter-point cut (67.7% vs 64.7% on Wednesday) – the probability of a quarter point cut at the July meeting ticked up to 10.3% versus 8.2% ahead of the CPI and PPI prints and Fed meeting. 

The November and December meetings are now forecasting a 30.4% and 65.7% probability, respectively, of a rate cut versus 26.5% and 62.5% on Wednesday. 

It’s still open for debate if we are about to embark on a concerted global monetary policy easing effort. It is unclear whether the Swiss National Bank would follow up on its March cut with another move this month. Meanwhile, the Bank of England appears unlikely to start an easing cycle this month as it assesses inflationary pressures. ECB President Christine Lagarde stated that policymakers are not necessarily moving to a “dialing-back phase.” 

Analysts at the BlackRock Institute recently wrote, “This is not your typical rate cutting cycle. Central banks are set to keep rates above pre-pandemic levels as inflationary pressures persist.”