The markets are no longer sure that the 12 Federal Open Market Committee (FOMC) members would decrease interest rates in March after the first meeting of 2024. 34% of the market expects a rate decrease next meeting, down from 73% a month ago. I expect the Fed to decrease rates at most by the end of the second quarter.
Economic data implies a March rate drop is unlikely. The job market is tight, December inflation was more than predicted, and retail sales climbed more than forecast last month. Much of this was due to the holiday season, and the January blues will likely decrease inflation and expenditure. A resurgence later in the quarter is predicted after this brief respite. Overall, the economy is hot, and economic data drives FOMC monetary policy.
December inflation climbed from 3.1% to 3.4%, while core inflation—the Fed's favored measure—up 0.3% MoM and 3.9% YoY, surprising the market. Our data shows that services have driven inflation in previous months, while luxury goods sales increased in December.
Tight labor markets have worsened services inflation. December's unemployment rate was 3.7%, despite job market weakening rhetoric. Recent weeks have seen just around 210,000 first unemployment claims, significantly below historical levels. No month has experienced an employment loss since 2020.
In November, pay growth accelerated to 6.5% YoY from 5.7% in October, spurred in part by union pressure. Higher salaries, credit spending, and consumer optimism have boosted consumer expenditure. U.S. retail sales up 0.6% MoM and 5.6% YoY in December, above experts' estimates.
It appears the market misread Fed Chairman Jerome Powell's comments given this economic background. The Chairman said rate decreases are “into view,” but he has maintained that his core goal is 2% inflation, even if it slows the economy. No indications at today's meeting imply a change of heart. Powell was more hawkish than the market thought for most of 2023, but his posture has softened in recent months. Core inflation is roughly double the Central Bank's objective, so a decrease this quarter is unlikely.
This year's FOMC shifting of guard may make it more hawkish. Only San Francisco Fed president Mary Daly has explicitly argued for rate decreases among the four new members. Richmond Fed president Tom Barkin wants more inflation cuts, Atlanta's Raphael Bostic predicts cuts in the second half, and Cleveland's Loretta Mester says market expectations are “a little bit ahead” of the Fed, a diplomatic understatement.
It would also be fascinating to observe if the committee can make choices together in 2024. After all, this year's monetary policy calls may be more controversial than 2023's. A split FOMC might postpone interest rate reduction.
After a rough 2023, the Fed can win the inflation war. The economy is hot and the macroeconomic backdrop is unpredictable, making inflation predictions harder than last year. Geopolitical upheaval and other things might raise inflation. The impacts of monetary tightening take time, therefore an economic downturn may shortly occur. The Fed will struggle to balance its dual mandate this year.
While the economy is robust and sticky inflation looms, the Fed will likely be cautious on interest rates until the situation clears out. Even if core inflation falls to 2%, we don't expect the aggressive reduction cycle many commentators predicted. Higher-for-longer rates are here to stay, and the market must adapt.
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