Fed Minutes Signal Rates to Stay High with Cuts Possible Late 2024
U.S. stocks declined for a second day on Wednesday after the release of the December Federal Reserve meeting minutes dampened investor hopes for imminent interest rate cuts.1 The Dow Jones Industrial Average fell 0.4%, the S&P 500 dipped 0.2%, and the tech-heavy Nasdaq Composite dropped 0.7%.2
The minutes showed Fed officials believe rates will need to remain restrictive for “some time” to curb inflation, though they see scope to slow and eventually stop the pace of hikes.3 Most officials projected leaving rates unchanged through 2023 before delivering cuts in 2024 if inflation continues to ease as expected.
“With inflation showing signs of moderating but still well above the Fed’s 2% target, policymakers indicated interest rates would likely need to remain elevated for ‘some time’ before becoming sufficiently restrictive,” said Daniel Vernazza, chief international economist at UniCredit Bank.4
Path to Rate Cuts Remains Unclear
While the minutes validated market expectations that rate cuts could come in 2024, the exact timing and speed of reductions remain uncertain.5
“There is still debate within the FOMC on how fast to cut rates once the tightening cycle ends,” said Bob Miller, head of Americas Fundamental Fixed Income at BlackRock. “While asset prices are pointing to cuts beginning in the second half of 2024, this view is not universal within the Committee.”6
Many officials emphasized the need for “appropriate caution” on timing rate cuts to avoid a resurgence of inflation.7
“Participants observed that an unwarranted easing in financial conditions, especially if influenced by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability,” the minutes said.8
Table 1: Fed Officials’ Projected Path of Interest Rates
|Median Federal Funds Rate Projection
Source: Federal Reserve
This indicates the Fed is strongly leaning against prematurely cutting rates in response to equity and bond market pressure.
Mohamed El-Erian, chief economic advisor at Allianz, tweeted that the minutes “totally contradict” the market narrative of cuts in the second half of 2024. He expects cuts to start only in 2025 after inflation falls to 3%.9
Inflation Showing Signs of Easing
The minutes did highlight that officials see inflation continuing to ease this year. They noted falling commodity prices, improving supply chains, and moderating wage gains as factors that should help bring down pricing pressures.10
“Participants observed that monthly inflation data showed a welcome reduction in the monthly pace of price increases,” the minutes said. “participants expected inflation to continue to moderate over 2023.”7
However, officials stressed a key uncertainty is the persistence of core inflation in the services sector even as goods prices decline. They want clear evidence that services inflation is on a “sustained downward path” closer to 2% before contemplating rate cuts.7
This indicates markets are underestimating the Fed’s high bar for cutting rates, according to economists.11
“If you take them at face value based solely on the inflation outlook, rate cuts are off the table for 2024,” said Michael Gapen, head of U.S. economics at Bank of America. “They’d need to see compelling evidence that inflation, including services prices, are on course back to 2% on a sustained basis first.”12
Stock Market Impact
The less dovish minutes have led to a pullback in stocks as investors lower expectations for Fed rate cuts this year.13 Some economists believe hopes for cuts starting in mid-2024 are unrealistic based on the Fed’s latest signalling.
“Expectations for 150 basis points of cuts seems too aggressive over 2024,” said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets. “It’s more reasonable to pencil in about 75 basis points in cuts next year following the end of the tightening cycle later this year.”14
JPMorgan strategists said the minutes are a reminder for investors not to underestimate the Fed’s “overarching hawkishness,” leading the bank to trim its 2024 rate cut forecast to just one 50 basis points move from two 50 basis points cuts previously.15
Others see more nuance in the minutes that leaves room for flexibility by the Fed to cut rates if economic weakness necessitates.
“We think there are enough conditionals in the minutes to support market pricing of rate cuts late this year,” said Michael Gapen, head of U.S. economics at Bank of America. “If activity slows over the course of 2023 and/or inflation comes in substantially lower, we suspect the Committee’s risk management preferences would shift in favor of supporting the economy.”12
With inflation showing signs of easing, focus will turn to key economic data like jobs, consumer spending and manufacturing gauges over coming months for clues on whether the Fed could shift to cutting rates to stave off recessionary risks. For now, officials have signaled that keeping rates at restrictive levels remains the priority to ensure inflation continues trending down toward their 2% goal on a sustained basis.
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