The biggest question for the economy and financial markets in the coming year isn’t about whether the Federal Reserve will cut interest rates; it’s about why they might do it.
Inflation has dropped significantly from its highest levels in decades last year, making rate cuts in 2024 a real possibility. After keeping interest rates steady for the third meeting in a row, Federal Reserve Chair Jerome Powell and his colleagues are likely to use their “dot-plot” to predict rate cuts in 2024. However, these cuts may not be as substantial as investors and economists expect.
When To Expect the First Rate Cut in 2024?
The timing of the first rate cut, as expected by economists, is in June. If the Fed lowers rates in response to cooling inflation, it’s generally good news for the economy and investors. It suggests that the Fed is close to achieving a soft landing, where inflation returns to pre-pandemic levels without causing a recession. Such a scenario could stabilize or even reduce stock market volatility.
But if the Fed cuts rates because the economy is in trouble, that’s a different story. It would signal rising unemployment and a hit to corporate profits as demand weakens.
Diane Swonk, Chief Economist, puts it simply: “We want rate cuts when the economy and inflation cool down, not because we’re in a recession.”
The reason behind Fed rate cuts will determine how many cuts that will occur.. If the economy is in or near a recession, the Fed is likely to act quickly and aggressively. On the other hand, if there’s no severe downturn in sight, anticipate smaller and slower rate cuts.
Will Rate Cuts Prevent a Recession, or Just Limit the Damage?
Market traders have adjusted their expectations after the better-than-expected jobs data. They now see less than a 50% chance of the first rate cut happening in March and anticipate the Fed reducing rates by just over 1% in 2024. Earlier this month, they expected a 60% chance of cuts starting in March, with around five quarter-point cuts for the year.
The current market predictions are more in line with what economists are forecasting. A survey of Fed experts by Bloomberg suggests the central bank will lower rates by 1 percentage point next year, with the first cut coming in June.
Most of the economists surveyed believe the economy will avoid a recession in 2024. Nearly three-quarters say the initial rate cut will be due to easing inflation, not an economic downturn.
What Role Does Inflation Play in the Fed’s Rate Cut Strategy?
Economists stress that lower inflation is the key driver for Fed rate cuts in 2024. The Fed, being cautious about inflation, is expected to be more conservative in forecasting rate cuts compared to the markets. They might indicate just a 0.5 percentage point reduction in their projections.
Brett Ryan, a senior U.S. economist at Deutsche Bank, explains, “We don’t expect the Fed to suggest cuts in the first half of the year.”
Powell himself has stated that it would be “too early” to speculate about when the Fed might ease its policies. He even leaves open the possibility of raising rates if necessary to control inflation.
Historically, it has taken about eight months from the last rate hike for the Fed to initiate a rate cut. With the Fed’s last rate hike in July, that puts a March rate cut in the realm of possibility.
Joseph Lavorgna, Chief Economist believes that a March rate cut is still quite likely, given that there are three more employment reports before then. If the labor market deteriorates and inflation softens, the Fed may feel compelled to act.
Lavorgna predicts that the central bank will cut rates by 1.25 percentage points next year, with the possibility of more cuts. This may not completely prevent a recession, but it could help limit the damage.
In contrast, Bank of America’s Chief U.S. Economist, Michael Gapen, expects the economy to steer clear of a recession. He predicts the Fed will cut rates by 0.75 percentage points in 2024, with the first cut happening in June. Gapen believes these rate cuts will be in response to decreasing price pressures, not an economic downturn.
Conclusion
In summary, there are many factors at play, but one thing is clear: the Federal Reserve’s decisions regarding interest rates in 2024 will have a significant impact on the economy and financial markets. Whether it’s a response to cooling inflation or a more serious economic issue, these decisions will shape the financial landscape in the year ahead.
