Thursday’s inflation report could challenge the market outlook for big Fed rate cuts

Economists
expect
that
inflation
nudged
higher
in
December,
a
trend
that
could
call
into
question
the
market’s
eager
anticipation
that
the
Federal
Reserve
will
slash
interest
rates
this
year.

The
consumer
price
index,
a
widely
followed
measure
of
the
costs
folks
pay
for
a
wide
range
of
goods
and
services,
is
projected
to
have
risen
0.2%
in
the
final
month
of
2023,
or
3.2%
for
the
full
year,
according
to
Dow
Jones.

At
a
time
when
the
Fed
is
fighting
inflation
through
tight
monetary
policy
including
elevated
rates,
news
that
prices
are
holding
at
high
levels
could
be
enough
to
disrupt
already-fragile
markets.

“The
Fed
did
its
policy
pivot,
and
the
data’s
got
to
support
that
pivot,”
said
Jack
McIntyre,
portfolio
manager
at
Brandywine
Global
Investment
Management.
“The
market
seems
to
have
gotten
excited
that
the
Fed’s
going
to
have
to
do
more
than
what
the
Fed
thinks
in
terms
of
rate
cuts
now.
…
The
market
got
ahead
of
itself.”

There
is
certainly
a
wide
gap
between
what
the
Fed
has
indicated
in
terms
of
rate
cuts
and
what
the
market
is
expecting.

After
months
of
insisting
that
easier
monetary
policy
is
still
a
ways
off,

central
bank
policymakers
in
December
penciled
in
three
quarter-percentage-point
rate
cuts
by
the
end
of
2024,
effectively
a
policy
pivot
for
this
inflation-fighting
era.

Minutes
from
that
meeting
released
last
week
did
not
indicate
any
discussion
about
a
timetable
for
the
reductions.

Markets
hold
a
different
view.

Traders
in
the
fed
funds
futures
market
are
pointing
to
a
strong
chance
of
an
initial
rate
cut
in
March,
to
be
followed
by
five
more
reductions
through
the
year
that
would
take
the
benchmark
overnight
borrowing
rate
down
to
a
range
of
3.75%
to
4%,
according
to
the
CME
Group’s

FedWatch
gauge.

If
inflation
data
such
as
Thursday
morning’s
CPI
release
and
Friday’s
producer
price
index
don’t
show
stronger
inflation
progress,
that
is
liable
to
cause
more
volatility
in
a
year
when
stocks
have
already
gotten
off
to
a
rocky
start.

“We’re
going
to
see
it
across
all
markets,
because
it’s
going
to
be
that
dynamic
between
what
the
Fed’s
doing
and
what
the
market
expects
them
to
do,”
McIntyre
said
of
a
likely
volatile
time
ahead.
“Ultimately,
they’ve
got
to
come
together.
It
probably
means
that
right
now,
the
market
needs
to
give
back
some
of
the
rate
cuts
that
they
priced
in.”

A
smattering
of
public
statements
since
the
December
meeting
of
the
Federal
Open
Market
Committee
provided
little
indication
that
officials
are
ready
to
let
down
their
guard.

Fed
Governor

Michelle
Bowman
said
this
week
that
while
she
expects
rate
hikes
could
be
done,
she
doesn’t
see
the
case
yet
for
cuts.
Likewise,
Dallas
Fed
President
Lorie
Logan,
in
more
pointed
remarks
directed
at
inflation,

said
Saturday
that
the
easing
in
financial
conditions,
such
as
2023’s
powerful
stock
market
rally
and
a
late-year
slide
in
Treasury
yields,
raise
the
specter
that
inflation
could
see
a
resurgence.

“If
we
don’t
maintain
sufficiently
tight
financial
conditions,
there
is
a
risk
that
inflation
will
pick
back
up
and
reverse
the
progress
we’ve
made,”
Logan
said.
“In
light
of
the
easing
in
financial
conditions
in
recent
months,
we
shouldn’t
take
the
possibility
of
another
rate
increase
off
the
table
just
yet.”

Logan,
however,
did
concede
that
it
could
be
time
to
think
about
slowing
the
pace
of
the
Fed’s

balance
sheet
reduction.
The
process,
nicknamed
“quantitative
tightening,”
involves
allowing
proceeds
from
maturing
bonds
to
roll
off
without
reinvesting
them,
and
has
cut
the
central
bank’s
holdings
by
more
than
$1.2
trillion
since
June
2022.

The
Fed’s
central
mission
now
is
calibrating
policy
in
a
way
that
it
doesn’t
ease
too
much
and
allow
inflation
to
return
or
hold
policy
too
tight
so
that
it
causes
a
long-anticipated
recession.

“Policy
is
too
restrictive
given
where
inflation
is
and
likely
where
it’s
going,”
said
Joseph
Brusuelas,
chief
economist
at
tax
consultancy
RSM.
“The
Fed
is
clearly
positioning
itself
to
put
a
floor
under
the
economy
as
we
head
into
the
second
half
of
the
year
with
rate
cuts,
and
create
the
conditions
for
reacceleration
of
the
economy
later
this
year
or
next
year.”

Still,
Brusuelas
thinks
the
market
is
too
aggressive
in
pricing
in
six
rate
cuts.
Instead,
he
expects
maybe
four
moves
as
part
of
a
gradual
normalization
process
involving
both
rates
and
the
rollback
of
the
balance
sheet
reduction.

As
for
the
inflation
reports,
Brusuelas
said
the
results
likely
will
be
nuanced,
with
some
gradual
moves
in
the
headline
numbers
and
likely
more
focus
on
internal
data,
such
as
shelter
costs
and
the
prices
for
used
vehicles.
Also,
core
inflation,
which
excludes
volatile
food
and
energy
prices,
is
expected
to
increase
0.3%
on
the
month,
equating
to
a
3.8%
rate
compared
to
a
year
ago,
which
would
be
the
first
sub-4%
reading
since
May
2021.

“We’re
going
to
have
a
vigorous
market
debate
on
whether
we’re
going
back
to
2%
on
a
durable
basis,”
Brusuelas
said.
“They’ll
need
to
see
that
improvement
in
order
to
set
the
predicate
for
modifying
QT.”

Former
Fed
Vice
Chair

Richard
Clarida
said
policymakers
are
more
likely
to
take
a
cautious
approach.
He
also
expects
just
three
cuts
this
year.

“The
progress
on
inflation
for
the
last
six
months
is
definitely
there.
…
There’s
always
good
news
and
bad
news,”
Clarida
said
Wednesday
on
CNBC’s
“Squawk
on
the
Street.”
“Markets
maybe
are
a
little
relaxed
about
where
inflation
is
sticky
and
stubborn.
But
the
data
is
definitely
going
in
the
direction
that’s
favorable
for
the
economy
and
the
Fed.”

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