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Fed Likely to Cut Rates Amid Prolonged Deflation
Bet players are raising the stakes for a reduction in the rate this March as they anticipate a consistent deflationary trend in the economy. This would make the Federal Reserve pivot towards a strategy to cushion the impact of the most swift series of rate hikes the country has seen in 40 years.
According to a recent note from Jefferies, slowed inflation over the coming months are expected to coerce the Fed into reducing the funds rate by 25 bps during their meeting on March 20. They highlight the Fed's hesitation towards the potential pitfalls of maintaining such high rates for an extended period.
Investing.com's Fed Rate Monitor Tool recorded a significant jump in odds for a March cut from 21.6% the previous week to an unexpected 57.9%.
First Cut to Mitigate Real Rates
The urgency for rate cuts stems from fears that an unchecked real fed funds rate could trigger a deceleration in growth beyond what is forecasted, possibly pushing the economy towards a recession. Jefferies predicts a string of deeper cuts in the following months to counteract possible spikes in unemployment rates.
They anticipate a decrease of 50bp at the subsequent four meetings, bringing the funds rate to a low of 2.75-3.0% by September. This is substantially lower than the Fed's own rate projections of 5.1% for the end of 2024.
Declining Economic Strength Could Force Fed's Hand
Despite recent upticks in economic indicators, such as the revised Q3 GDP rate which now stands at an annualized 5.2%, the economy seems to be heading towards a terrain that requires Fed intervention. Deutsche Bank argues that the full effect of the rapid rate cuts have yet to significantly dampen the economy.
Support for their observation comes from a rise in credit card delinquencies, high yield defaults, and a climb in the unemployment rate, all signs of mild economic instability according to Deutsche Bank. This trend is expected to continue and consumer spending is predicted to soften in the near future.
Jefferies suspects that job cuts in businesses could begin towards the end of 2023 or early 2024 as companies try to trim expenses and cope with waning profit margins. They attribute this to the rising struggle of businesses to pass on rising costs to customers and slowing inflation.
Resistance Amid Fed Leadership
Even as Fed Chairman Jerome Powell warned against jumping to conclusions about rate cuts on Friday, the panglossian pioneers remained steadfast. Powell's caution was undermined with inflation rates showing signs of slowing and Fed Governor Christopher Waller discussing the possibility of rate cuts.
Fed's cautious approach and steady rate maintenance since July seems to stem from fear of overcorrecting. Powell indicated on Friday that the possibilities of over- and under-tightening were becoming more balanced. The cooling inflation has Fed members tapping their toes as they head into the quiet period before the December 12-13 meeting.
