5 cut, 6 cut, 7 cut more.
Investors are chomping at the bit for the Fed to slash interest rates. Just a couple of weeks ago, March was to mark the first rate cut of the cycle, according to the CME’s FedWatch Tool.
And, going forward, the most likely path wasn’t simply a gradualist approach. The CME’s tool reflected (and still reflects) an aggressive series of rate cuts, up to seven 25 bp rate cuts at one point.
Yet, it’s not the first time investors have bet on a dovish Fed. It’s not the first time they jumped the gun on a Fed pivot or pause.
Honestly, I’m not sure why investors are so optimistic that the Fed will cave to their demands.
You’re thinking, “But hasn’t inflation slowed down?” It has. The core PCE Index is just below 3%. That would give the Fed cover to ease. The six-month annualized core PCE is just under 2%. That would also give the Fed cover to ease.
The core CPI has slowed but is near 4%, and progress has stalled. That’s far from the definition of price stability.
More importantly, GDP in the second half of 2023 expanded at an annual pace of over 4%. Nonfarm payrolls shocked just about everyone in January, rising by 335,000. Notably, the same thing happened last year when payrolls surged by about 500,000 in January.
It’s early, but the Atlanta Fed’s GDPNow Model puts Q1 growth at over 4%.
The consumer isn’t backing down, fiscal stimulus is in the pipeline, and companies are adding to payrolls. If the Fed is truly data-dependent, I’m unsure what would justify the five rate cuts that investors currently expect, let alone the six or seven projected in January.
Put another way, there are few signs the economy needs that much monetary stimulus.
For starters, the Fed has never embarked on an aggressive easing without a recession. Do investors expect the ever-elusive recession to materialize this year?
Well, based on the recent series of highs in the market, the answer seems to be a resounding no. Recessions and bear markets go hand in hand; at least, that’s what 60+ years of market history tells us. If investors were fretting over a recession today, we wouldn’t be seeing major indices near highs.
Final thoughts
Mostly upbeat data are not conducive to an aggressive cycle. Besides, the Fed has openly opined on the lessons of the 1960s and 1970s. Inflation has slowed down, but we’ve been on this merry-go-round before.
So, why are investors so optimistic the Fed will aggressively backpedal on rates this year?
