Inflation Persists, Delaying Rate Cuts and Frustrating Investors
Inflation in the United States is proving to be more stubborn than expected, causing frustration among investors who were hoping for rate cuts from the Federal Reserve. Recent data from two inflation reports indicate that the central bank’s pivot to rate cuts may be delayed, leading to a longer period of tighter monetary policy.
The consumer price index, a closely watched indicator of inflation, showed a decline of two-tenths of a percentage point to 3.1% for the year ending in January. While this is a decrease, economists had anticipated a larger drop. On a monthly basis, inflation actually increased to 0.3%, which translates to an annual inflation rate of 3.6%. This reading is considered too high for the Fed’s liking.
The wholesale inflation report also surprised investors, with the producer price index showing a month-to-month increase of 0.3%, more than double the forecasted amount. The “core” PPI inflation, which excludes volatile food, energy, and trade services prices, jumped 0.6% in January alone, surpassing economists’ predictions.
“These reports are indicating that inflation is sticking around for a while. It’s a little like the guest that won’t go away,” said Mark Hamrick, Bankrate’s senior economic analyst. “And while the guest may have one foot out the door, it’s still with us.”
These findings are frustrating for investors who had anticipated rate cuts from the Fed in the first quarter of this year. The central bank has been raising interest rates since March 2022, bringing its target rate to a range of 5.25% to 5.50%. However, since pausing rate hikes in July, the Fed’s plans for rate cuts have become less certain.
Currently, the majority of investors expect the Fed to maintain steady rates after the March meeting of the Federal Open Market Committee. The probability of interest rates remaining the same is pegged at over 66% for the May meeting, with investors betting on a pivot following the June gathering.
The Fed updates its projections for rate changes, inflation, gross domestic product (GDP), and unemployment every other meeting. In December, officials projected three rate cuts for 2024, while investors were anticipating twice that number. The upcoming March meeting will be closely watched to see if there are any changes to the Fed’s projections.
The strong labor market has given the Fed some leeway in keeping interest rates higher for longer. Despite expectations of job losses when the Fed began raising rates, the economy has added jobs every month since December 2020. In January, an additional 353,000 jobs were added, and the unemployment rate remained at a historically low 3.7%.
The resilience of the job market in the face of tightening monetary policy has been a pleasant surprise. “Federal Reserve officials can maintain, in their words, a little more patience with respect to the process [of] lowering rates,” said Hamrick.
However, the Fed must balance its dual mandate of stable prices and maximum employment. Keeping rates too high for an extended period could potentially harm the labor market and even push the economy into a recession.
Just over a year ago, economists were predicting that the United States would already be in a recession by now. However, U.S. economic output has exceeded expectations, with positive GDP growth every quarter of last year. In the final quarter of 2023, GDP grew at a 3.3% annual rate, bringing total growth for the year to 2.5%. The Atlanta Fed’s “GDP Now” tracker predicts a strong GDP growth rate of 2.9% for the first quarter of 2024.
As investors eagerly await the Fed’s next moves, it remains to be seen how long inflation will persist and when rate cuts will finally be implemented. The March meeting will provide valuable insights into the central bank’s projections and its approach to balancing inflation and employment in the coming months.
