Evening Brief – 04.03.24

One Cut?

The markets continue to price in moderate probabilities that easing will begin by the end of the second quarter, but incoming data and recent comments from Fed officials provide more support for putting the timeframe for rate cuts further out.

The rather robust manufacturing PMI data for March (50.3%, up from 47.8% in February) released this week revealed that economic activity in the manufacturing sector expanded after declining for 16 consecutive months.

Meanwhile, Atlanta Fed President Raphael Bostic, who is a voting member of the Fed’s rate-setting committee this year, told CNBC on Wednesday that he now believes the Fed should make only one rate cut this year, down from the three expected by Fed officials in March.

“If the economy evolves as I expect, and that’s going to be seeing continued robustness in GDP, unemployment and a slow decline of inflation through the course of the year, I think it would be appropriate for us to do start moving down at the end of this year, the fourth quarter,” he said.

Using the U.S. 2-year Treasury yield as a guide, the bond market remains dovish. The yield closed Wednesday at 4.69%, near a four-month high but still significantly below the current federal funds target range of 5.25% to 5.50%, indicating that the market continues to price in a near-term interest rate cut.

The 2-year yield has been predicting a rate cut(s) since last December when Fed Chair Jay Powell signaled a policy shift, only to be proven wrong month after month. The argument is further weakened by recent economic data, which indicate that economic growth remains strong.

According to the Atlanta Fed’s GDPNow model, the initial GDP report for the first quarter will indicate economic growth increased by 2.8% (real seasonally adjusted annual rate). Although this is well below the scorching 3.4% growth rate seen in the fourth quarter of 2023, a 2.8% gain would signal solid growth, implying that rate cuts may be unwarranted.

Along with Bostic, other Fed officials raise questions about the timing of interest rate cuts. The crucial element is inflation, and recent reports indicate that pricing pressure remains sticky, implying that progress toward the Fed’s 2% inflation objective will take longer than previously anticipated.

“I continue to think that the most likely scenario is that inflation will continue on its downward trajectory to 2% over time. But I need to see more data to raise my confidence,” said Cleveland Federal Reserve President Loretta Mester in prepared remarks on Tuesday. “I do not expect I will have enough information by the time of the FOMC’s next meeting to make that determination.”

The likelihood of a dovish turn beginning in two months is decreasing. According to the CME FedWatch Tool, the odds of a June rate cut are now about 62%, down from 70% for much of the previous four weeks.

“While June is not off the table, market conviction for a first Fed cut by then is fading,” wrote ING strategists in a research note. “In the coming weeks we can expect some Fed speakers to remain vocal about June cuts, but in the end the data will be the deciding factor.”