After nearly two years of focusing on controlling surging inflation by raising interest rates, the Federal Reserve now faces the task of determining when to start lowering rates. Inflation has been decreasing faster than expected, while the economy and labor market have remained resilient. The Fed is anticipated to keep its key short-term rate steady at a 22-year high of 5.25% to 5.5% during a two-day meeting that begins on Tuesday. However, some economists predict the Fed will begin reducing the benchmark rate as early as March, which could be signaled at this week’s gathering. This potential move is expected to further drive the S&P 500 stock index that reached a record high last week due to the prospect of continued inflation deceleration and Fed rate cuts. Nonetheless, several top forecasters believe the central bank will keep its options open by affirming that it has finished hiking rates without making a definite signal about an imminent rate cut. Market forecasts imply a 46% chance of a rate cut in March, with expectations of six rate decreases throughout the year, double the forecast made by the Fed last month. Goldman Sachs economist David Mericle suggests that the Fed will aim to keep the possibility of a March rate cut open without sending a decisive signal.
Will the Fed Lower Interest Rates in 2024?
Market indicators suggest that a March rate cut is a close call, with about a 46% chance of such a move. Overall, markets project six rate cuts this year to a range of 3.75% to 4%, twice the amount forecasted by the Fed last month. Mericle believes that the Fed will likely begin reducing the rate in mid-March but adds that Fed Chair Jerome Powell will probably emphasize that their decision will be based on two additional months of inflation data leading up to that meeting. Economists generally agree that the Fed will most likely remove from its post-meeting statement the assertion that the “extent of any additional (rate increases)” will depend on the delayed effects of prior rate hikes and economic and financial developments. Instead, the Fed may refer to any “adjustments” to the key rate, indicating that a rate cut is at least as likely as a rate hike, according to Barclays. However, determining when to make a complete shift and begin reducing rates is more challenging.
Why Would the Fed Decrease the Federal Funds Rate?
Traditionally, the Fed decreases rates to stimulate a slowing economy or during a recession. Currently, the economy grew by a strong 3.3% in the fourth quarter and a solid 2.5% for the entirety of 2023, with a sturdy consumer spending. While some economists expect growth of just under 2% this year, slightly below the pre-pandemic pace, there are predictions of a mild recession. As a result, there is no immediate need for the Fed to lower rates, according to Mericle.
What Is the Current Inflation Rate?
The Fed’s preferred inflation measure, the personal consumption expenditures index, increased by 2.6% annually last month, down from a peak of 7% in the summer of 2022. A core measure that excludes volatile food and energy items slipped to 2.9%, the lowest since March 2021. However, these readings are still above the Fed’s 2% target, yet core inflation has been running below 2% on an annualized basis since June. Based on these measures, it appears that the Fed’s goal of returning inflation to 2% has been achieved, according to Barclays. Consequently, Barclays states that the Fed’s key rate is already more restrictive than desired after adjusting for inflation and should theoretically be trimmed to avoid excessively hampering the economy to ensure further decline in inflation.
Is Inflation Expected to Rise Again?
There are concerns that inflation may not have been completely eradicated. The slowdown in average pay increases, which impact inflation, due to a rise in immigration may have peaked, and there are signs of a shrinking labor force and an uptick in yearly wage growth. Additionally, there is a risk of renewed supply-chain disruptions due to military conflict in the Red Sea. While the personal consumption expenditures inflation is nearing the Fed’s goal, the consumer price index and the core consumer price index are up significantly, well above the Fed’s target. Therefore, economists anticipate that the Fed will take a cautious approach this week and not disclose its expected timing for a rate cut, according to Ryan Sweet, chief U.S. economist of Oxford Economics.
