Traders work on the floor of the New York Stock Exchange during afternoon trading session on April 9, 2024 in New York City.
Michael M. Santiago | beautiful images
As recently as January, investors had high hopes that the Federal Reserve was about to embark on a campaign of interest rate cuts aimed at reversing some of the most aggressive policy tightening in decades. .
Three months of inflation data have brought those expectations back to reality.
March consumer price index report Wednesday helped validate worries that inflation was becoming more difficult than thought, giving credence to caution from Fed policymakers and ultimately dashing market hopes that the central bank will approve up to seven interest rate cuts this year.
“The math shows it will be very difficult in the near term to get inflation down to the Fed’s target level,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “It’s not like you’ve limited inflation to the Fed’s target, but that won’t happen immediately.”
There was little good news to come out of the Labor Department’s CPI report.
Both the all-commodities, food and energy indexes were above market consensus on a monthly and yearly basis, putting the inflation rate well above the Fed’s target. Headline CPI rose 0.4% on the month and 3.5% from a year ago, exceeding the central bank’s 2% target.
Danger below the surface
But other danger signs beyond the headline numbers have emerged.
Service prices, excluding energy, rose 0.5% and were up 5.4% from a year ago. A relatively new calculation that markets are watching, which takes core services and subtracts housing — it’s called the “super core” and is closely watched by the Fed — increases at an annual rate of 7.2% and increased by 8.2% in three years. -month in year.
There is also a risk that the “base effect” or comparison with previous periods will make inflation even worse as energy prices in particular are rising after falling at the same time this year. last.
All of that leaves the Fed in a holding position and the market worried about the possibility of not raising interest rates this year.
of CME Group FedWatch Tools, which calculates the probability of an interest rate cut as expressed by futures market prices, changed significantly after the CPI release. Traders now see only a slim chance of a rate cut at the June meeting, which had previously been popular. They also pushed the first round of cuts to September and now expect just two cuts by the end of the year. Traders are even pricing the likelihood of no cuts at 2% by 2024.
“Today’s disappointing CPI report makes the Fed’s job even harder,” said Phillip Neuhart, director of market and economic research at First Citizens Bank Wealth. “The data doesn’t completely eliminate the possibility of the Fed acting this year, but it certainly reduces the likelihood of the Fed cutting overnight interest rates in the next few months.”
Market reaction
Of course, the market does not like news about CPI and was sold off strongly Wednesday morning. The Dow Jones Industrial Average fell more than 1% and Treasury bond yields moved higher. The two-year treasury bondsparticularly sensitive to the Fed’s interest rate moves, which increased to 4.93%, an increase of nearly 0.2 percentage points.
There could still be good news on inflation. According to Joseph LaVorgna, chief economist at SMBC Nikko Securities, factors such as rising productivity and industrial capacity, along with slower money creation and falling wages, could alleviate some of the pressure.
However, “inflation will remain higher than needed to warrant Fed policy easing,” he added. “In this regard, the Fed’s cuts will be pushed into the second half of the year and are likely to be reduced by only 50 basis points. [0.5 percentage point] with risks tilted towards even less easing.”
In some respects, the market has only itself to blame.
The pricing of seven interest rate cuts earlier this year was in stark contrast to guidance from Fed officials. However, when policymakers in December raised their “dot plot” index to three rate cuts compared with two expected in September, it caused Wall Street to become skeptical. madness.
“The market has gone overboard with that assumption,” said Schwab’s Sonders. That doesn’t make sense based on the data.”
However, she said that if the economy remains strong – GDP is forecast to grow at a 2.5% pace in the first quarter, according to the Atlanta Fed – the immediate reaction to Wednesday’s data may pass.
“If the economy is sluggish there, I think the majority of the market is fine,” Sonders said.
