The Bright Light Arrives! The Fed Could Cut Interest Rates In July

Jakarta, CNBC Indonesia – The good news has finally arrived, inflation in the United States (US) has continued to show a decline in recent months. Market participants are also increasingly confident that the US central bank (The Fed) will relax the rate of increase in interest rates.

UBS chief economist, Arend Kapteyn, even predicts the Fed will cut interest rates starting in July.

“We think they (the Fed) will cut interest rates this year. We think the first one will be in July,” Kapteyn said as reported by Market Insider, Tuesday (10/1/2023).

Kapteyn’s projection is faster than market expectations. According to CME Group’s FedWatch tool the market sees the Fed raising interest rates by 25 basis points respectively in February and March with probabilities of 94% and 76%. With this projection, the Fed’s interest rate peak will be at 4.75% – 5%.

Moreover, the same tool shows the Fed is expected to cut interest rates by 25 basis points in September with a probability of 34%, as well as a month after. So at the end of the year the market sees the Fed’s interest rate at 4.25% – 4.5%.

This projection could occur if inflation continues to decline. based inflation consumer price index (CPI) in the US in December 2022 is reported to have grown 6.5% year-on-year (yoy), much lower than the previous 7.1%. The CPI is also the lowest since October 2021.

Core CPI excluding the energy and food sectors also fell to 5.7% from 6% previously, and is at its lowest level since December 2021.

The Fed actually uses inflation based personal consumption expenditure (PCE) as a reference for setting monetary policy. PCE inflation is usually released at the end of the month, and has also shown a decline.

In November, PCE inflation recorded growth of 5.5% (yoy) in November last year, down from 6.1% (yoy) in the previous month. Meanwhile, core PCE inflation, which is the Fed’s main benchmark, fell to 4.7% (yoy) from the previous 5% (yoy) and was at its lowest level since July 2022.

Kapteyn predicts that core PCE will continue to fall to 2.1% at the end of this year.

“Our difference with the Fed is they see core PCE at 3.5% at the end of 2023, we’re looking at 2.1%,” Kapteyn said.

Reinforcing expectations the Fed will cut interest rates more quickly, the US construction sector contracted for the first time in two and a half years.

The Institute for Supply Management (ISM) last Friday reported that the US service sector contracted for the first time in two and a half years.

ISM reports purchasing managers’ index (PMI) services fell to 49.6 away from the previous month’s 56.5. A reading below 50 is contraction, while above it is expansion.

This contraction is a sign of the darkening of the US economy in 2023, a recession is already looming.

To note, the service sector is the largest contributor to US gross domestic product (GDP) based on business sector. Its contribution is never less than 70%.

With a recession that is certain to occur and inflation continues to decline, the opportunity for the Fed to cut interest rates in the middle of this year is certainly open. This could be good news, with interest rate cuts, the recession is unlikely to deepen.

As a result, the world recession will not be deep, and the Indonesian economy will also benefit. Moreover, if the Fed loosens its pace of interest rate hikes, and then cuts them in the middle of the year, Bank Indonesia’s (BI) increases will of course also be lower, and could have a good impact on the economy.

[Gambas:Video CNBC]