Earlier this year investors grew positively euphoric over the idea of multiple interest-rate cuts by the Fed.
Interest-rate futures pointed to six or seven reductions for 2024, even though the median December forecast from Fed officials called for just three cuts.
The enthusiasts were excited by the slide of inflation. The Fed’s favored inflation indicator is the personal consumption expenditures price index, excluding food and energy. That measure has slid to 2.8% in February from 5.6% in February 2022.
That’s still a ways away from the Fed’s 2% target. And the economy continues to hum along, with annualized growth of 3.4% in the fourth quarter.
So it’s no wonder the median Fed forecast in March still called for only three rate drops this year.
Oliver Contreras/for The Washington Post via Getty Images
The Fed's key rate is the federal funds rate, the rate it wants banks to charge each other for overnight loans to maintain required reserves. It has been at 5.25% to 5.5% since the Fed's July 2023 meeting.
The fed funds is the base on which all U.S. interest rates are derived.
Zero Fed rate cuts?
Vanguard Chief Economist Roger Aliaga-Díaz said in March that the Fed may even refrain from cutting interest rates at all this year. “The U.S. economy has proved far more resilient than anyone could have expected, despite the Fed’s efforts to cool it,” he said.
Related: Fed inflation gauge cools modestly in February, but spending rate leaps
“The Goldilocks outcome of strong growth and lower inflation was achieved by a timely expansion in the supply side of the economy. That’s mainly better-than-expected gains in the workforce and productivity.” And those factors aren’t going away, he said.
Torsten Slok, chief economist of Apollo Global Management, went even further than Aliaga-Diaz, predicting zero rate cuts for this year, rather than just saying that’s a possibility.
“The bottom line is that the Fed will spend most of 2024 fighting inflation. As a result, yield levels in fixed-income will stay high,” Slok wrote in a commentary cited by Bloomberg.
“The market now has to realize that the data is just not slowing down, and the Fed pivot [toward a tighter policy] has given an additional tailwind to the economy and to financial markets and financial conditions and to capital markets,” he told Bloomberg separately.
Goldman Sachs shifting view on interest rates
Goldman Sachs economists previously expected the first Fed interest rate cut to happen in December 2024. It revamped that outlook in mid-December 2023, saying the Fed would cut rates three times, with the first cut occurring in the third quarter of 2024. They targeted four cuts in February, with the first one slated for May.
Now, the influential investment firm's updated outlook is back to three rate reductions this year, with the first coming in June. They also anticipate four cuts in 2025, plus one in 2026. Their prediction for terminal interest rates is 3.25%-3.5%.
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Meanwhile, “rethinking the neutral [federal funds] rate is likely to be the Fed's next big debate,” they said. The fed funds rate is the interbank overnight loan rate. That’s the rate that the Fed adjusts to pursue its policy.
The Fed’s target for the rate currently stands at 5.25%-5.5%. And it pegs the neutral rate at 2.5%. The neutral rate is the prevailing rate when inflation and unemployment are near optimum levels, so the Fed doesn’t need to raise or lower rates.
“We expect [Fed officials] to raise their estimates of the long-run neutral rate because econometric estimates of neutral that the Fed staff tracks have risen,” the economists said.
“We also expect Fed officials to conclude that short-term neutral is higher than long-term neutral because the fiscal deficit is much larger than usual. And broad financial conditions have not tightened commensurately with the rise in the funds rate, limiting transmission to the economy.”
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