Expectations have collapsed for Federal Reserve rate cuts in 2024 after the third hotter-than-expected US inflation report in a row.
The Bureau of Labor Statistics reported that the Consumer Price Index rose 3.5% in March from year-ago levels, well above forecasts for a 3.4% increase and a jump from February’s 3.2% inflation rate.
In the bond market, expectations now centre on the Fed making its first cut in the federal-funds rate in September. Before Wednesday’s CPI report, the average expectation was that the central bank would lower rates by a quarter of a percentage point in June from the current target range of 5.25%-5.50%. In contrast, at the start of this year, the Fed had been expected to start cutting rates in March.
“In one word, the report was discouraging for the Fed and the prospects of a June cut. Inflation is proving sticky,” Bank of America economists wrote Wednesday morning.
Fed Rate Cuts Hinge on Inflation Outlook
With the economy continuing to grow at a healthy pace, the Fed’s ability to start cutting rates has been seen as heavily dependent on continued progress in reducing inflation after upward pressure on prices hit a 40-year peak in 2022.
The higher-than-predicted inflation reading for March followed above-forecast CPI reports in January and February, fuelling worries that the progress seen in reducing inflation during 2023 has stalled out.
With Fed officials emphasising the need to feel comfortable with the inflation outlook before beginning to lower rates, the bond market reacted sharply to Wednesday’s CPI report.
When Will the Fed Cut Rates?
In the futures market, where bond traders place bets on the direction of interest rates, odds that the Fed will cut rates at its June policy-setting meeting plunged from 56% on Tuesday to just under 19% following the CPI report, according to the CME FedWatch Tool.
Bond traders also now predict that the Fed will hold rates steady even at its July meeting. The first rate cut is now seen as more likely to come in September. Bond traders peg the odds of the Fed lowering the funds rate to a 5.00%-5.25% target at 46%, compared with 32% odds of rates still being at current levels and a 20% chance of rates being cut by half a point.
Pimco economist Tiffany Wilding, wrote: “In addition to the jobs report released last week, [the March CPI report] complicates the timing of the Fed’s rate cuts. With this latest data, there is a strong case to push out the timing of the first cut past mid-year.”
Expectations for the number of rate cuts in 2024 have also changed dramatically. Coming into the year, investors were anticipating five cuts starting in March. That has now been scaled back to slightly favouring two cuts, with a target range of 4.75%-5.00% to close out the year. Bond traders still see a more than 30% chance that only one cut will be in the offering in 2024.
