Suddenly, expectations for Fed rate cuts are all over the place

By Greg Robb

Previous view of three rate cuts beginning in June now seems antiquated

Federal Reserve interest-rate policy expectations have become like a boat without an anchor drifting down a river, moving randomly between the possibility of three rate cuts this year and a chance of no cuts at all.

The Fed's story, as told by Chair Jerome Powell, has been that the labor market is softening and the level of interest rates is putting enough downward pressure on demand, which, if it continues, should keep inflation moving lower, allowing the Fed to cut interest rates sometime this year.

But the hot March unemployment report seriously dented this story.

Former Treasury Secretary Lawrence Summers put it succinctly on Friday.

It looks like the economy is reaccelerating and that the Fed's interest-rate stance is not so tight, Summers said in his weekly comments on the economy on Bloomberg Television.

Gregory Brown, professor of finance at the University of North Carolina Kenan-Flagler Business School, said expectations are unanchored.

"It feels like we came into this year with just a really strong consensus view: It wasn't a question of if they were going to cut, it was how much they were going to cut. And now we're starting to see a little bit of hedging on that."

Based on the current economic data, Brown said he wouldn't be surprised if the Fed didn't cut interest rates at all this year.

The economy added 303,000 jobs in March, the strongest gain in 10 months.

With the economy growing more strongly than average, "in simple supply-and-demand terms, demand is outstripping supply, and that's inflation," he said.

At the same time, adjusted for inflation, the Fed's benchmark interest rate is about 2%. That seems only "slightly restrictive" on growth, and that's about where rates should be, Brown said.

The Fed has penciled in three cuts this year. The market had been pretty certain that cuts would start in June, but doubts are creeping in.

Cutting rates would be like hitting the accelerator, Summers said.

Jeffrey Cleveland, chief economist at Payden & Rygel, said "June is off the table. Maybe September could be an option."

If the Fed can't cut in June, the central bank might stay on hold all the way until March 2025, said Aditya Bhave, economist at Bank of America Securities.

That's because inflation readings in the second half of this year are likely to be flat or slightly higher, boosted by technical "base effects." In simple terms, that means the soft readings of the second half of 2023 will drop out of the annual inflation-rate calculations, naturally pushing the new annual rate higher.

Does that mean the Fed should move in June?

In a note, Bhave said there are pros and cons for the central bank moving in June. On the one hand, the Fed might want to "strike while the iron is hot" with inflation relatively low. On the other hand, it could look bad if inflation suddenly looks firmer in the wake of a cut.

The Fed will get three consumer price-inflation readings before its June decision.

Fed officials have said they want to have greater confidence that inflation is coming down before cutting rates.

Brian Bethune, professor of economics at Boston College, said he thinks progress on inflation is going to stall, given supply shocks from the shipping problems that have developed this year, even before the collapse of the bridge in Baltimore.

These shocks will be amplified in the U.S. industries that are "concentrated" - in other words, where only a few big businesses compete, like retail gasoline - he said.

"There is no reasonable expectation other than prices are going be choppy, with periods of rising and then falling," he said.

Bethune said his best guess now is the Fed only cuts rates twice this year.

Matthew Luzzetti, chief U.S. economist at Deutsche Bank, said he still believes the Fed will cut in June, but the Fed "really needs to get softer inflation prints over the next few months for that outcome to be realized."

He predicted the Fed will proceed with a two-stage cutting cycle, with initial cuts - maybe one to three moves - and then a pause. Any further cuts would require a weaker growth and labor-market outcome, he said.

That means there could only be a few rate cuts over this entire cycle.

At the moment, the Fed projects it will be able to steadily cut its benchmark rate to a range of 2.5% to 3.1% by 2026.

James Glassman, former economist with JPMorgan Chase, said this is what everyone should be watching.

"How many moves they make this year is less interesting than what they think is the endgame," Glassman said, in an email.

-Greg Robb

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04-07-24 1641ET

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