The waning confidence in the Federal Reserve’s inclination to reduce interest rates is becoming more evident in the market, posing a significant concern for both the economy and the stock market.
Two forthcoming economic reports are anticipated to aid investors in understanding the decisions of policymakers and gauging market responses to potential changes in monetary policy.
Initially, investors will gain insight into the comprehensive economic growth picture for Q4/2023 when the U.S. Department of Commerce publishes the GDP estimate on Thursday, January 25 (U.S. time).
Economists surveyed by Dow Jones predict a 1.7% GDP growth in the final three months of 2023, marking the slowest growth since the 0.6% contraction in Q2/2022.
Subsequently, the Commerce Department will unveil December figures for the Personal Consumption Expenditures (PCE) price index, the Fed’s favored inflation indicator. Experts anticipate a 0.2% increase in core PCE (excluding volatile energy and food prices) from the previous month and a 3% rise compared to the same period last year.
Both reports are expected to garner attention, particularly given the ongoing trend of inflation data approaching the Fed’s 2% target but not yet reaching it.
Chicago Fed President Austan Goolsbee emphasized in a January 19 interview that “Data is what people should be watching to determine how the Fed’s interest rate trajectory will unfold. This is not a secret; fundamentally, the top priority is the data. If there is clear evidence that inflation is returning to the target level, we may loosen policy”.
The unveiling of the two reports coincides with a period in which the market is adjusting its expectations regarding potential interest rate reductions.
As of the last Friday afternoon (U.S. time), CME Group data indicates that investors essentially foresee the Federal Reserve maintaining unchanged interest rates during the meeting on January 30-31. While this development is not groundbreaking, the probability of the Fed initiating an interest rate cut in March has markedly decreased from 81% a week ago to just 47.2%.
Concurrently, investors are now anticipating the Fed to execute interest rate cuts only 5 times, each by 25 basis points, throughout the year. Previously, the expectation was for the Fed to cut rates 6 times.
The shift in investor sentiment is a response to data indicating higher-than-anticipated consumer spending growth of 0.6% in December and a reduction in initial claims for unemployment benefits to the lowest level since September 2022.
Moreover, some associates of Mr. Goolsbee, including Governor Christopher Waller, New York Branch President John Williams, and Atlanta Branch President Raphael Bostic, have signaled a reluctance to hastily lower interest rates, even as the cycle of interest rate hikes concludes.
“I don’t like to be boxed in, and we still have a lot of economic reports. Look further ahead. If we continue to make unexpected progress on inflation, we will consider these factors when determining the tightening of policy”, remarked Mr. Goolsbee.
The official also emphasized a specific concern: inflation in housing. The December Consumer Price Index (CPI) report revealed a 6.2% increase in housing costs compared to a year earlier, well exceeding the 2% inflation target.
However, other aspects warrant consideration. A new index from the U.S. Department of Labor, named the New Rent Index, indicates a diminishing trend in housing inflation, reflecting a 4.6% decrease in Q4 2023 compared to a year earlier, which is double the rate of the previous quarter.
In a recent analysis, economist Andrew Hollenhorst from Citigroup remarked, “In the near future, we believe that inflation data will help the Fed become more dovish”. However, Citigroup also forecasts that inflationary pressures will persist, potentially causing a delay in the first interest rate cut until at least June.
At present, the impact and outcome of rate cuts remain uncertain, especially if the Fed opts for 4 or 5 cuts instead of meeting the market’s high expectations.
Several factors could sway policy prospects in either direction. For example, a continued robust surge in the stock market might prompt the Fed to worry about potential future inflation. Escalating political tensions or economic growth exceeding expectations could also prompt policymakers to be more contemplative and careful.
Komal Sri-Kumar, President of Sri-Kumar Global Strategies, suggests, “These economic and political developments could drive up inflation, putting pressure on both short-term interest rates and long-term U.S. Treasury bond yields. Will the Fed be compelled to increase the federal funds rate instead of cutting interest rates? It’s an interesting thought. Don’t be surprised if officials discuss this direction in the coming months”.
By. Pham Thanh Bien
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