Investors are nervous this week as Federal Reserve officials prepare to signal how many interest rate cuts remain likely in 2024.
Most market observers believe that decision makers will lower their expectations. The question is before how much.
The new forecast on Wednesday will come in the form of a so-called “dot chart,” a graph updated quarterly that shows each Fed official's expectations about the direction of the federal funds rate.
In March, dot charts revealed a consensus among Fed officials on three cuts. Now that forecast is in doubt after a series of flat inflation readings, dovish comments from Federal Reserve officials and a US labor market that added more jobs than expected in May.
Most investors now expect just more than one cut for 2024.
“I think the policy path will change a little bit,” said Esther George, former president of the Federal Reserve Bank of Kansas City, who expects the average among 19 policymakers to fall to one cut even as a large number of officials continue to call for two cuts. .
“My expectation is that the points will emerge and confirm what I think the market has rebounded, which is lower interest rate cuts as inflation expectations hold steady.”
Fed Chair Jay Powell and his colleagues on the Federal Open Market Committee stress that they want to make sure inflation moves “sustainably” to their 2% target before starting cuts, and that in the meantime they expect to keep interest rates higher for longer. .
This position is not expected to change this week. Officials are widely expected to hold the Federal Reserve's benchmark interest rate steady on Wednesday, leaving it at its highest level in 23 years.
Mixed picture
Policymakers are expected to remain cautious as recent readings on inflation and the economy present a mixed picture.
The labor market added 272,000 nonfarm payrolls in May, far more than the 180,000 job additions economists had expected, but the unemployment rate rose to 4% from 3.9%.
Rates are not accelerating as much as they were during the first quarter, but the latest readings also do not show enough progress for the Fed to start cutting.
The year-over-year increase in the Fed's preferred measure of inflation — the “core” personal consumption expenditures index — was 2.8% in April, unchanged from March.
Another complication is that wages also show elasticity. Wage growth was stronger than expected in May, at 4.1%.
Fed officials will get a new reading from another inflation gauge, the Consumer Price Index, just hours before wrapping up their policy meeting on Wednesday. Continued moderation is expected to appear during May after an encouraging month of April.
The year-over-year change in the so-called “core” CPI — which excludes volatile food and energy prices that the Fed cannot control — is expected to fall 0% to 3.5%, compared with 3.6% in April. And 3.8% in March.
A CPI reading of 3.5% may not be enough to inspire confidence in the Fed, according to George.
“I think it's going to take a little longer to see what the trend is,” George said.
Betting on September
Powell explained that he believes the Fed will need more than a quarter of the data to make a judgment on whether inflation is falling steadily toward the central bank's 2% target.
The September meeting is viewed by many as an optimistic case for a rate cut given that the three inflation reports due between now and then will all need to show improvement for the central bank to pull the trigger.
Meanwhile, investor expectations about the number of interest rate cuts this year have swung wildly.
Odds of a first cut in September fell to nearly 52% after a hotter-than-expected jobs report released on Friday, and bets on a second rate cut narrowed to just over 38% in December.
Luke Tilley, chief economist at the Wilmington Trust, is more optimistic. The central bank is expected to have enough data to change its stance by the policy meeting on July 31.
He said inflation data in the first month of the second quarter helped calm concerns about hotter readings in the first quarter, and CPI data released on Wednesday will provide further reassurance.
“By July 31, they will have three more months of inflation data,” Tilly said. “I think they'll get back on their toes and take their heels off and be ready to cut. But it's really about how that data looks.”
Wednesday will also bring another new forecast from the Fed for investors to digest this week, as policymakers will also present new forecasts for inflation, the economy and unemployment.
There will be the usual high level of scrutiny on everything Powell says in his usual post-meeting news conference.
Wilmer Stith, a bond portfolio manager at Wilmington Trust, is looking forward to seeing whether Powell will take a tougher tone.
“Will he be like (Minneapolis Fed President Neal) Kashkari and the other members who say we need to be higher for longer?” Stith says.
“It's hard to say because if we continue to have the economic growth and the strength of the job market that we've seen, I don't even know why they would want to make one cut.”
Stith said he believes officials will cut interest rates twice. He added that if the Fed cuts just one point, it could add some volatility to the markets, although that is what investors are currently expecting.
George said there was a risk that the Fed would become too patient as it sought to ensure inflation was low. Holding interest rates high for too long can also sow the seeds of recession.
“That's the risk they're taking here, which is to say that time is on our side,” she said.
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