Market Views: Will the Fed hike or cut rates next?
Expectations for the US Federal Reserve (Fed) to lower interest rates multiple times in 2024 have dramatically reversed, now hinting at the possibility of an additional rate hike.
The shift in investor sentiment is being driven by sticky inflation and unexpectedly strong employment figures, challenging the initial forecast in a persistently high-interest rate environment.
Previously, markets were anticipating several rate reductions throughout 2024. However, recent economic data indicates that the economy is maintaining a robust pace, suggesting that measures to cool it down may be required for longer than initially thought.
We turned to the asset management industry to gauge their expectations on whether the Fed will increase interest rates before implementing cuts in 2024, and to determine the anticipated number of rate cuts for the year.
The following responses have been edited for clarity and brevity.
Tom Porcelli, chief US economist
PGIM Fixed Income
The broadening economic resiliency clearly put expectations for Fed policy in play, and the latest market pricing indicated the Fed’s narrower window to implement rate cuts.
Considering its stated desire to see a “string” of constructive inflation reports (generally interpreted as three reports), inflation readings would need to quickly meet that requirement for the Fed to cut in July.
If it does not cut in July, that brings the Fed to its politically fraught meetings in September and November with the polarising US presidential election looming.
If economic conditions moderate as the Fed anticipates, its December meeting could present the opportunity for a second cut this year. However, much would have to fall into place for cuts in July and December—such that we would place a higher probability on zero cuts than on two cuts.
That said, if the Fed is hindered from cutting rates this year, it could shift those into 2025, and, as this point, three cuts are expected next year.
The longer they wait to cut, the closer we get to the election. While the Fed has engaged in policy actions around elections, they have done so when the backdrop has unquestionably demanded an adjustment.
The longer the economy hangs in there (which we think it will), the harder it will be for them to justify starting an easing cycle around an election.
Naomi Fink, global strategist and managing director
Nikko Asset Management
As of March month-end, our view was that economic growth would be firmer and inflation higher than priced in by consensus, and since then markets have priced out multiple Fed cuts.
There still remains some potential for price rises to abate from here. Providing the economy also cools in coming months, a Fed cut may not be off the cards.
Equally, we do not see imminent recession, and see room for multiple cuts as limited.
One key trend underpinning “stronger for longer” growth is extremely accommodative financial conditions: equities have been buoyant with only limited correction so far; credit spreads are tight, and the market is absorbing issuance smoothly.
The “carry trade” is very much alive and vols are still on the low side. These easy conditions make it difficult to create a case for multiple rate cuts.
Another key trend is that global PMI’s are showing signals of bottoming; the manufacturing cycle is one source of favourable growth signals, even despite the firm inflation.
Our central scenario allows for one rate cut this year. Meanwhile, I would put the probability of no rate cut as higher than that of multiple rate cuts, unless in the event of an unexpected shock to the economy.
David Chao, global market strategist, Asia Pacific (ex-Japan)
Invesco
We maintain our expectation that the Fed is likely to institute its first rate cut sometime in Q2 or Q3, with a total of three cuts for the year.
While the US economy continues to positively surprise, so too have the recent CPI inflationary readings.
This doesn’t necessarily mean that the disinflationary progress has been abandoned – the process is just not as smooth as we hope it to be.
Let’s remember that the current interest rate environment remains quite restrictive.
Recent expectations by some market participants for a further rate hike have been catalysed by a robust labour market, higher than expected CPI and a blowout retail sales figures last month.
In our view, the possibility of a rate hike is minute.
No doubt the US economy remains highly robust, but some data suggests consumers are starting to experience some headwinds. For example, US credit card delinquencies in the fourth quarter reached the highest levels since 2012.
Strong immigration numbers have also helped to bring balance to labour markets.
The general sentiment from the cast of FOMC members seems to be that the current monetary policy is restrictive, though perhaps the urgency to loosen conditions has diminished.
Simona Mocuta, chief economist
State Street Global Advisors
Despite the dramatic hawkish repricing of the Fed path this year, the case for the start of a gentle easing cycle this summer, followed by a couple more cuts later in the year, remains strong.
This is especially true given the long lags with which monetary policy operates.
Inflation is much lower and much narrower than a year ago (even with latest numbers) the labour market is much better balanced, wage inflation has moderated materially, and inflation expectations are well anchored.
Winning the inflation fight does not require higher interest rates.
Given the elections calendar and given that core PCE inflation is likely to temporarily tick up in H2 2024 before resuming its downtrend in 2025, there is a risk that if the Fed does not avail the opportunity to ease by July, the window to do so at all this year could close.
The Fed path through the remainder of 2024 has indeed become very binary.
Michael Cross, global CIO, fixed income, and CIO, Asia
HSBC Asset Management
The post-Covid economic cycle has been unusual.
The FOMC Chairman has reiterated that humility in the face of uncertainty and preparedness to alter course as the data evolve are important elements of their monetary strategy.
As economist John Maynard Keynes said, “when the facts change, I change my mind.”
Stronger-than-expected data on US growth and inflation has led some FOMC members to state that they would not cut rates until they gained greater confidence that inflation was on track back to the 2% target. Higher Treasury yields reflect this.
Strength in the US economy has been underpinned by past fiscal stimulus, significant strength in asset prices and a marked decline in the savings rate. Fiscal stimulus is now turning to moderate fiscal drag, and we question how much further the savings rate can fall.
We also question whether current risky asset valuations are consistent with real yields at such relatively high levels. So, we expect growth and inflation in the US to moderate and we don’t expect the Fed to raise rates again.
We wouldn’t be surprised if markets price out expectations of 2024 rate cuts in the near-term, but we do think the Fed will cut in 2024.
Jonathan Liang, Asia ex-Japan head of investment specialists, global fixed income, currency and commodities
JP Morgan Asset Management
At the start of 2024, Fed Fund futures were pricing as many as six cuts this year, with the first cut starting as early as March.
But three consecutive months of hotter-than-expected CPI prints have shaken the confidence of policymakers that inflation is moving in the right direction.
Today, the market is unsure if the Fed could manage even two cuts this year, and some are even saying the next move by the Fed might be a hike, not a cut.
We think the risk of another rate hike is low. Inflation today is hovering around 3%, which means Fed Funds rate at 5.25 – 5.50% is still restrictive.
Indeed, the Fed governors' comments so far have generally emphasised the need to give restrictive rates time to work on inflation, rather than more hikes.
We think the stubbornness of first-quarter inflation might in part be driven by the significant loosening in financial conditions post the "dovish pivot" in November, when Chair Powell indicated that the Fed was no longer thinking about hikes but looking at when to cut.
If the Fed refrains from making similar comments again and instead emphasizes patience, financial conditions could tighten again, creating the right environment for rate cuts to happen.
So ironically, for the Fed to cut, they might have to say they won't cut.
Sven Schubert, senior investment strategist
Vontobel Asset Management
We are not surprised by stubborn inflation figures but we believe that further moderate progress is likely later this year, allowing the Fed to start the easing cycle at least in the final quarter of the year.
Slowly but surely, the labor market is losing steam and is, as Powell puts it, not "red hot" anymore.
Moreover, we have reason to believe that the savings buffer of households – accumulated during the COVID-19 years – is slowly showing signs of exhaustion, arguing for slowing consumption.
Therefore, we still hold the view of at least two rate cuts in 2024.
But surprisingly strong US inflation numbers have caught the Fed on the wrong foot.
While most influential Fed monetary policy committee members stick to their view of policy easing in 2024, for some, another rate hike seems not impossible anymore.
In our opinion, the inflation report released in May is crucial and will probably decide whether a first cut is still possible in the third quarter.
As many Fed officials want reaffirmation that inflation is returning to its deflationary path, two to three months of falling inflation in a row or, as the Fed puts it, 'a few months,' seem to be a precondition for the start of the easing cycle.
That means that a disappointing May release would probably close the door for cuts before September.