Traders work on the floor at the New York Stock Exchange (NYSE) in New York, U.S., January 19, 2024.
Brendan McDermid | Reuters
Markets have become less convinced that the US Federal Reserve is ready to push the button on interest rate cuts, an issue that is reducing the focus on the path of the economy and stocks.
Two major economic reports due out this week could go a long way in determining at least which way central bank policymakers might lean — and how markets might react to a shift in monetary policy.
Investors will get their first look at the broad picture of economic growth for the fourth quarter of 2023 when the Commerce Department releases its initial estimate for gross domestic product on Thursday. Economists polled by Dow Jones expect the total of all goods and services produced in the U.S. economy to have grown at a 1.7 percent pace for the final three months of 2023, which would be the slowest since down 0.6% in the second quarter of 2022.
A day later, the Commerce Department will release December’s reading of the personal consumption expenditures price index, a favorite Fed inflation gauge. The consensus expectation for core PCE prices, which exclude volatile food and energy components, is for a 0.2% increase for the month and 3% for the full year.
Both data points should get a lot of attention, particularly the inflation numbers, which are trending toward the Fed’s 2% target but not yet there.
“That’s what everyone should be watching to determine what the Fed’s interest rate path will ultimately be,” Chicago Fed President Austan Goolsbee said during an interview Friday on CNBC. “It’s not about secret meetings or decisions. It’s basically about the facts and what will allow us to become less restrictive if we have clear evidence that we are on track to return” inflation to target.
Diminished prospect of interest rate cuts
The releases come amid a market meltdown over where the Fed is headed.
As of Friday afternoon, trading in the Fed Funds futures market equated to almost no chance the rate-setting Federal Open Market Committee will cut at its Jan. 30-31 meeting, according to CME Group data, as indicated via of FedWatch tool. This is nothing new, but the odds of a cut at the March meeting fell to 47.2%, down sharply from 81% just a week ago.
Along with that, traders took an expected cut off the table, reducing the outlook for easing to five percentage points down from six previously.
The shift in sentiment followed data showing a stronger-than-expected 0.6% increase in consumer spending in December and initial jobless claims falling to the lowest weekly level since September 2022. Additionally, several of Goolsbee’s colleagues, including Governor Christopher Waller, New York Fed President John Williams and Atlanta Fed President Rafael Bostic all issued comments indicating they are at least in no rush to cut even if the hikes are likely done.
“I don’t like to tie my hands, and we still have weeks of data,” Goolsbee said. “Let’s take the long view. If we continue to make phenomenal faster-than-expected progress on inflation, then we should take that into account in setting the level of restraint.”
Goolsbee noted that a particular area of focus for him will be housing inflation.
December’s consumer price index report said housing inflation, which accounts for about a third of the CPI’s weighting, rose 6.2 percent from a year earlier, well ahead of a pace consistent with inflation 2 %.
However, other measures tell a different story.
A new Labor Department measure, known as the New Tenant Rent Index, points to a lower path for housing inflation. The index, which measures prices for new leases signed by tenants, fell 4.6% in the fourth quarter of 2023 from a year ago and more than doubled from the quarter.
Monitoring data and other factors
“In the very near term, we believe the inflation data will cooperate with the Fed’s smooth plans,” Citigroup economist Andrew Hollenhorst said in a client note.
However, Citi predicts that inflation is persistent and likely to delay the first reduction until at least June.
While it’s unclear how much of a difference timing makes, or how much it matters if the Fed only cuts four or five times compared to the market’s more ambitious expectations, market outcomes appear to be tied to expectations for monetary policy.
There are many factors that change the outlook in both directions — a The continued stock market rally may have the Fed worried about more inflation in the pipeline, as could an acceleration in geopolitical tensions and stronger-than-expected economic growth.
“Keeping alive the possibility of higher inflation, these economic and geopolitical developments could put upward pressure on both short-term interest rates and long-term yields,” said Komal Sri-Kumar, president of Sri-Kumar Global Strategies. his weekly purchase note.
“Could the Fed be forced to raise the Fed funds rate next move instead of cutting it?” he added. “An interesting thought. Don’t be surprised if there is more discussion along these lines in the coming months.”