When will the FED start the cutting cycle?

On Friday 26th April we will see the March data of the US Federal Reserve's preferred price index: the private consumption deflator/PCE. While awaiting the data release, find out what managers expect Powell and the Fed to do and how they are navigating this uncertainty in the markets.

The risk of 'going back to 1970s inflation'

Charlotte Daughtrey, Equity Investment Specialist at Federated Hermes Limited

With inflation proving stickier in 2024 than many imagined, the path to interest rate cuts may not be as smooth as the market hopes.  The Fed continues to maintain that they are data dependent, and the data does not currently support moving early. They are keen to avoid the mistakes of the 1970s (when rates were cut too early and the US economy suffered a second, more painful round of inflation) and this appears to be a factor in the current ‘pause’ with rates remaining at more elevated levels.  We expect the Fed to continue to exert continued caution, therefore, with rate cuts potentially pushed into 2025 and beyond.

Probability of 'no landing' and oil price rebound

Paul Diggle, Chief Economist at abrdn

Our central scenario expects the US Federal Reserve to make two rate cuts this year, in September and December, as growth and inflation are likely to moderate slightly in the second half of the year. However, we seriously consider the risk that there will be no cuts, or even that the next move will be a hike. In fact, we assign a cumulative probability of 35% to the "no landing" and "oil price rebound" scenarios, in which monetary policy is maintained or even tightened this year.

On the growth front, activity remains strong, thanks to robust consumption and business, looser fiscal policy, high net immigration and rising productivity. These factors may fade in 2024, so we believe growth will moderate. There are upside risks of continued above-trend growth or an increase in trend growth itself, as well as downside risks of a more significant slowdown.

Regarding inflation, the CPI rose again strongly in March. As the year progresses, it becomes increasingly difficult to attribute this strength to residual seasonality and other peculiarities. We continue to believe that modest disinflation is ahead, given the decline in wage growth, and the decline in market rents; a factor that suggests that housing inflation will moderate at some point. Thus, core CPI should fall to 2.5% year-on-year in the summer, but the advance could stagnate over the rest of the year as base effects become less helpful. However, there is plenty of historical evidence pointing to a "difficult last leg" in which inflation would remain above target or even pick up, so we take these risks very seriously.

On the monetary policy front, the upside surprise in the CPI means that the Fed does not yet see the necessary progress to start cutting rates in the summer. We believe that the Fed will wait until at least September before cutting rates, and then cut rates again in December. However, the risks are tilted towards an even later start date if inflation does not decelerate. Despite this U-turn, Powell has maintained that policy remains tight, setting a high but not insurmountable bar for further tightening. Geopolitical risk could lead to a sharp rebound in oil prices, which could lead to no cuts or even further hikes.

Inflation volatility puts Fed rate cuts in doubt

George Brown, Senior US Economist at Schroders

Will the Federal Reserve cut rates this year? That is the question on investors' minds after core inflation surprised on the upside in March for the third month in a row. Futures markets are now pointing to fewer than two rate cuts in 2024, down from six or seven in January.
The shift in market expectations has not been countered by Fed Chairman Jerome Powell. After the March inflation data, he admitted that "it will probably take longer than expected" for the central bank to have the confidence to start easing monetary policy.
The likelihood of monetary policy easing materialising this year is now in doubt. Any tightening will be conditional on conclusive evidence that inflation is converging back to target. This will require not only that sequential inflation declines, but also that labour market conditions become more balanced.

Could the stage be set for a rate cut at Jackson Hole in August?

Another factor that could delay any rate cut is a significant escalation of the situation in the Middle East. Our latest economic forecasts included a risk scenario in which conflict breaks out in the region, dragging down Western nations.

This scenario would disrupt major shipping channels and oil supplies, leading to higher global energy and commodity prices. Given concerns about tight labour markets and second-round effects on wages, this would lead central banks to delay the start of any easing cycle.
Apart from this risk, it is unlikely that there will be sufficient progress in inflation or employment data for the Federal Open Market Committee (FOMC) to be confident of cutting rates at its June or July meetings. We suspect that sufficient progress will have been made by the time the Fed's rate-setting committee meets in September.

Powell could lay the groundwork for an easing policy in his keynote speech at the Jackson Hole economic symposium in August. A rate cut in September would also have the added advantage of being accompanied by an updated "dot plot", which the FOMC could use to communicate its expectations about the timing and extent of any easing.

Our expectation is that this would be followed by two more rate cuts at the December and March meetings

However, we continue to believe that the Committee will have difficulty justifying a further rate cut. Inflation should then be on target, while unemployment would remain below average, which would mean that the FOMC has fulfilled its dual mandate of stabilising prices and full employment.
This three-cut cycle would amount to a cumulative easing of 75 basis points (bps), the same as the one overseen in 2019, which itself was modelled on the mid-cycle adjustment made in the mid-1990s.

The US elections may influence the timing and extent of easing

But the balance of risks is clearly tilted towards later and smaller cuts. While data developments will be the determining factor, we do not rule out the possibility that the 5 November elections could influence the timing and extent of easing.

For example, the FOMC could wait until the December meeting to cut rates by 50 basis points or leave them unchanged, depending on whether the election outcome is expected to have a material impact on the economic outlook.

There is also a good chance that the FOMC will not ease policy at all this year. We currently give a 40% probability to this scenario, a risk that, in our view, is being underestimated by the market. And if inflation starts to accelerate, the Committee's next move may not be a cut but a hike.

How will the Fed manage inflation uncertainty?

Mauro Valle, Head of Fixed Income, Active Management at Generali Asset Management

The market could continue to move in a range in the coming days, awaiting the Fed's preferred inflation gauge PCE data (expected to be in line with previous data) and the Fed meeting to assess Powell's stance on further cuts.

Over the last week, US rates moved around 4.60% (after touching 4.69%), while real rates consolidate above 2.20% and break even (BE) rates remained relatively stable at around 2.40%. The latest economic data was mixed: strong retail sales and industrial production, in line with expectations in housing and unemployment data. But the dominant theme in the market is how the Fed will handle the uncertainty about inflation: during the week we will hear the PCE index deflator, which is expected to be in line with previous months at 0.3%, and, the following week, the Fed meeting. The market is closed to ruling out a cut in June (less than 20% probability) and is pricing in a 1.5 cut in December. In the coming days we expect US interest rates to remain above 4.5%, with no new highs in sight.