Odds Are The Fed Won’t Cut Rates In 2024

It seems pretty clear that Jay Powell is not rushing to cut rates. He has spoken twice since the February PCE report, and both times, he has emphasized patience regarding the Fed’s next steps. He has also, to some degree, played down the elevated January and February inflation reports.

While the Fed is unlikely to raise rates in 2024, the question is whether they will cut them. The odds seem to be shifting slowly in favor of no cuts.

Powell has repeatedly noted that monetary policy is restrictive, yet the market disagrees: 1-, 2-, and 5-year inflation swaps have all been trending higher in recent months, and while they are still nowhere near their highs in 2022, they’re certainly at the upper end of the range over the past year.

The same can be said for 1-, 2-, and 5-year inflation breakevens, which have also increased in recent weeks. 1-year and 2-year breakevens haven’t been this high since early 2023. One would think that if policy were tight, the effects would be in the economic data, and the markets would be pricing in lower inflation expectations for the future, not higher inflation expectations.

Additionally, Powell has continued to dismiss the higher inflation readings of January and February, and rightfully so, given that two data points aren’t enough to prove or disprove anything. But indeed, short-term inflation swaps have also markedly moved higher in recent months. Inflation swaps now see the CPI y/y inflation rate remaining above 3% through July.

In addition, key commodity prices like copper and gasoline are surging. These ingredients go into manufacturing, and the March ISM prices paid increased to the highest level since the summer of 2022. The rising prices of gasoline and copper will feed into higher readings of inflation in the manufacturing sector in the months to come and potentially into goods inflation.

So while inflation has undoubtedly fallen a lot over the past year, it doesn’t mean it will continue to decline, and more importantly, all of the warning signs of inflation coming back to life are in full force and suggest that inflation readings over the next couple months aren’t expected to be pretty, and if commodity prices continue to rise, those outlooks will only grow worse.

The idea that policy is tight comes from where real rates are. When looking across the curve, real rates range from 1.8 to about 2%, which could be considered restrictive. However, the real rate determined to do this may not be correct. The real rate is simply the nominal rate minus the market-based expected inflation rate, which has been rising as late, as noted above.

But more broadly, if you look at the 10-year nominal rate and subtract core PCE, you see that the “real” rate is 1.55%. But more importantly, if you compare the real rate of 1.55% today and historic trends, the difference between the core PCE and the 10-year is at the same level as from 2013 until 2019 when the Fed Funds rates were much lower. The real rate today, even when measured against the 1960s until 2009, is much lower than historical trends with the expectation of 1974 and 1975.

Even when taking the Fed’s Fund rate and subtracting the core PCE rate, we find that policy is not as tight as it was during prior periods. Yes, it’s tighter than the 2017/18 hiking cycle, but it’s nearly 100 bps lower than the cycle leading up to the 2008 financial crisis and well below the period in the 1990s. This also paints an image of policy becoming less restrictive as you go out across the yield curve, with policy being the most restrictive at the front of the yield curve.

It seems clear that the market is pricing higher inflation rates for the next few months. Inflation expectations and swaps are all moving higher. Meanwhile, the 10-year and Fed’s Fund rate minus the core PCE suggest that policy is just not as resistive as prior periods over 50 to 60 years. It seems hard to walk away with the idea of a tight policy.

It seems clear that Powell is in no rush to cut rates, and that’s a good thing because, at least based on where the market sees inflation going, currently, it seems more likely than not that policy isn’t as restrictive as thought and that barring a significant economic slowdown, rate cuts in 2024 won’t be coming.