While investors are settling on the idea that the Fed will not cut interest rates soon, there is another scenario that is gaining some support with the possibility of financial market turmoil this year.
It is a risk that inflation will end up rebounding, leaving policymakers in the position of needing to respond quickly. In a note to clients on Wednesday, economist Tiffany Wilding of California-based bond fund Pimco said: “Recent data highlighted how progress in inflation in 2024 may be slower and more subtle than in 2023.”
Since December, investors have largely focused on the prospects for cuts of at least three-quarter percentage points in the Federal Reserve's benchmark interest rate in 2024 and on a slowdown in inflation, although policymakers oppose the idea of starting to ease restrictions. Policy as soon as March. Now, officials are looking for a sustained decline in inflation toward 2% before they are ready to act, which will likely take more time.
What has not been fully factored into financial markets yet is the possibility that the central bank will need to raise interest rates again, having already raised borrowing costs by more than five full percentage points since March 2022. Federal funds futures remain in place. Most are priced in at least five quarter-point rate cuts by December. When policymakers talk about eventually adjusting monetary policy, it is in the context of lowering interest rates – not raising them – this year.
However, there was some recognition that the Fed's monetary tightening efforts so far have not been enough to rein in the US economy.
Earlier this week, Minneapolis Fed President Neel Kashkari wrote in an online article that the central bank's interest rate and balance sheet policies “may not be as hawkish as we had assumed,” and that the so-called “neutral” level at which interest rates… Neither adaptive nor restricted may have increased. But he stopped short of suggesting that there was a need to raise interest rates again, and pointed to the need to keep interest rates at their current levels of between 5.25% and 5.5%.
The steady stream of data since last Friday's nonfarm payrolls report, which showed a higher-than-expected gain of 353,000 for January, reinforces the view that the economy has not yet collapsed. On the other hand, annual core inflation based on the Fed's preferred index is trending toward 2%, but it has not done so long enough to make officials confident.
See also: Does January jobs report put interest rate hikes on the table? Probably not, but watch this space, says the economist
At Pimco, Wilding said she remains committed to the possibility of a soft landing for the US economy. However, she said the risk of persistent inflation appears “particularly evident in the US, where we believe growth could be more resilient than in other emerging market countries.” [developed-market] “Economies.”
“We are watching for risks in both directions: the possibility of stagnant growth, or the possibility of a return of inflation,” Wilding wrote. “We also believe the Fed is likely to respond quickly and decisively to rising inflation. Central bankers do not want a repeat of the recent price hikes.”
Financial markets on Wednesday appeared relatively calm after Federal Reserve Governor Adriana Kugler said it was necessary for inflation to return to 2%. The three major US stock indexes DJIA SPX COMP closed higher, while Treasury yields ended little changed after a strong $42 billion auction of 10-year bonds. Oil price gains remained largely limited in light of the prospects for a potential ceasefire between Israel and Hamas in Gaza.
Wilding is not alone in her views. In January, James Solloway, chief market strategist and senior portfolio manager at Pennsylvania-based SEI SEIC, said:
He warned that inflation was “far from dead” and said he doubted it could fall to 2% “without some degree of pain.” Brent Schott, chief investment officer at Milwaukee-based Northwestern Mutual Wealth Management, called wages “the only ember left that could reignite inflation.”
