Since the Nov. 1 Federal Reserve policy-setting meeting, market expectations on interest rates have taken a dovish turn. Tuesday’s publication of the minutes from that meeting could provide a sobering reminder that the Fed’s thinking may lag that of the markets.
Following last week’s inflation data that showed consumer and producer price inflation continued to slow, U.S. interest rate markets were pricing a 65% likelihood that the Fed would cut rates by May 2024. Since the end of October, ETFs that track the likely path of interest rates have been moving lower. On Monday, the Global X Interest Rate Hedge ETF RATE stood at 28, down from a peak of 31.88 on Oct. 19.
Fears are building that economic growth will slow along with corporate profits if the Fed maintains its “higher for longer” stance. There are already signs in purchasing manager index data and other regional U.S. industrial surveys that demand is slowing.
“The near-term risk is that the market has gotten ahead of itself,” said Marc Chandler, chief market strategist at Bannockburn Global Forex.
“The U.S. data are likely to confirm a sharp slowdown at the start of Q4, but the market is pricing in nearly four rate cuts, with around a 75% chance the first one is in May.”
Inflation Outlook Softens
Official CPI inflation data, published last Tuesday, showed the headline rate falling to 3.2% in October after a 3.7% print in the previous month and lower than an expected fall to 3.3%. The core rate, minus volatile food and energy prices, was a little stickier, down to 4% from 4.1% in the previous month.
The data prompted a bullish response from equity investors, with the S&P 500 gaining 2.3% last week, while the SPDR S&P 500 SPY – the ETF which tracks the index – climbed by the same percentage.
On Friday, CME Group’s chief economist Bluford Putnam told Benzinga that inflation was already below 2% if the owner equivalent rents (OER) metric of headline CPI – which he calls a “fiction” – was stripped out.
“We're in great shape on inflation and the market, over the last two or three weeks, has realized that inflation is not the issue. But the Fed is looking at core inflation still between 3% and 3.5% – so they could keep rates higher for longer,” Putnam said.
November Meeting Recap
At the November meeting, the Fed voted unanimously to keep the Fed Funds Rate in a range between 5.25%-5.5% and Chairman Jerome Powell said the central bank was “proceeding carefully” with respect to future policy decisions.
But the Fed certainly seems to have at least one foot in the hawkish camp, with the statement that accompanied the Nov. 1 decision saying that policymakers were still assessing whether it might need to do more in terms of policy tightening this year or next.
What analysts Expect From The Minutes
Few surprises are seen coming from the minutes. Rising expectations for a second-quarter rate cut may be dimmed by Fed caution if the minutes reiterate the “do more” stance of the Nov. 1 statement.
Economists at HSBC were somewhere between the two camps: “We do not forecast any additional rate hikes going forward and project the first Fed rate cut in the third quarter of 2024.”
Pantheon Macroeconomics was a little more dovish: “Our core view is leaning towards the idea that by the end of 2024, the Fed will be worrying about inflation falling too far in 2025, and will be responding by easing rapidly,” said Chief Economist Ian Shepherdson, who expects the first rate cut in spring 2024.
Jane Foley, senior FX strategist at Rabobank, said the market may have got ahead of itself on rate cut expectations: “The market will be using US economic data releases and Fed-speak in the coming days and weeks to pre-empt the FOMC and establish whether it has been too hasty in its pricing of rate cuts.”
Photo: Federal Reserve
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