From seven rate cuts to three and now possibly zero, Wall Street’s expectations for how many rate cuts the Federal Reserve will cut in 2024 are rapidly becoming outdated.
Just a few months ago, evidence of rapidly falling inflation suggested the Fed could move aggressively toward normalizing interest rates this year, with initial market forecasts suggesting the central bank would be on track to cut the federal funds rate to 3.5% by the end of the year from just over 5.25% now.
However, a string of strong economic data over the past few months — a solid jobs report, a pickup in manufacturing activity and the Atlanta Fed’s solid forecast for 2.5% first-quarter GDP growth — suggests the Fed will have to wait a while before lowering rates.
There is growing talk of no rate cuts in 2024
The idea that the Fed would not cut interest rates this year peaked last Thursday when Minneapolis Fed President Neel Kashkari said there was no reason to cut rates when the economy was performing so well.
“If the economy is running very attractively, people have jobs, businesses are doing well, inflation is coming down, why would you change anything?” Kashkari asked.
Fed Governor Bowman expressed a similar view on Friday, saying additional rate hikes, rather than rate cuts, might be needed this year if inflation remains above the Fed’s 2% long-term goal.
“While this is not my base case, I continue to believe that if the disinflationary process stalls or even reverses, we may need to raise the policy rate further at future meetings,” Bowman said.
Kashkari’s comments sparked a sharp sell-off in the U.S. stock market last Thursday. But those losses were largely recovered in Friday’s trading session following a strong March jobs report.
However, market veteran Ed Yardeni said investors may finally be waking up to the fact that rate cuts seen as a done deal earlier this year may end up being canceled in 2024.
"Investors may finally be considering the possibility of no rate cuts this year," Yardeni said in a note, adding that recent gains in oil prices represented upside risks to inflation.
Other experts who have argued against cutting rates this year include top economist Mohamed El-Erian, who said last month the Fed should wait "a few years" before cutting rates to combat persistent inflation, and Torsten Slok, who warned that the frenzy over artificial intelligence stocks would make it difficult for the Fed to cut rates.
“We are indeed in the midst of an AI bubble, and a side effect of that is that when tech stocks go up, financial conditions ease. That makes the Fed’s job much more difficult,” Slok said.
Futures markets are currently pricing in a 51% chance of the Fed's first rate cut in June. If there is no rate cut in June, a rate cut is unlikely in the second half of the year as the 2024 presidential election approaches, according to Bank of America.
The impact of delayed rate cuts on the stock market
In theory, a delay in the Fed's rate cuts would mean a fall in U.S. stocks. But in the long run, the ultimate factor driving stock prices higher is corporate earnings growth. Better-than-expected profits in the first quarter provided support for the stock market. Therefore, even though the rate cut rumors have faded, the stock market is still close to its all-time highs.
Billionaire investor Ken Fisher said positive growth prospects in a full-employment economy and increasing efficiency gains driven by the growing use of artificial intelligence mean stock prices could continue to rise even if interest rates remain high.
If the stock market and the economy can indeed withstand higher interest rates for an extended period of time, the Federal Reserve will have more room to cut rates aggressively to stimulate the economy when the next inevitable recession comes.
Ultimately, good news on the economy translates into good news for the stock market, as long as a recession is avoided.