Jan 22 / Alef Dias

Macroeconomics Weekly Report - 2024 01 22

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A cycle of interest rate cuts in the US is coming, but it depends on forward guidance

  • Faster-than-expected declines in inflation have been one of the positive variables watched by Fed members in the past 12 months, increasing the likelihood of rate cuts in March 2024.
  • However, it is important to observe that positive economic data and the resilient labor market in the United States provide incentives for a more conservative start to interest rate cuts, most likely in May of this year.
  • Furthermore, conflicts in the Red Sea are pressuring maritime costs, potentially exerting pressure on global inflation as more ships are changing their routes.

Introduction

Despite a costly disinflationary process, which resulted the interest rates to the range of 5.25%-5.50%, the monetary tightening are bringing prices down to the 2% level without causing a recession or significant harm to the labor market.

Soon the much-awaited easing of monetary policy by the market will, once it starts, help weaken the dollar, make commodities cheaper for holders of other currencies, and bolster global demand.

Therefore, it's crucial to pay close attention to the hints that will be given by the Fed board members at the upcoming meeting on January 30-31.

Image 1: US – Inflation (%)


             Source: U.S. Bureau of Labor Statistics

Image 2:  US – GDP Growth YoY (%)

Source:Bloomberg

Labor market gains have moderated, but continue resilient

The market anticipates monetary easing this year, although it may not occur at the pace anticipated, in the major economies worldwide. In the United States, for example, the Fed, in its latest meeting, projected cuts on the order of -75 basis points in 2024, as indicated by its dot plots chart. Several analysis firms suggest that the first interest rate cut may occur in March, but we believe it will take longer, happening at the meeting on April 30 and May 1.

Let's observe some important data that influences the decision-making of members of the American central bank. Despite inflation continuing to converge towards the 2% target, which is very positive, the labor market remains highly resilient, with real gains of 0.8% between December 2022 and December 2023. Also, the strong restrictive monetary policy has not pressured unemployment, which has stayed stable below 4%.

Image 3: US – Unemployement and Fed Funds Target

Source: Refinitiv

The American central bank may assume a risk by implementing an interest rate cut too early, potentially unanchoring market expectations. Also, the positive economic results and the resilient labor market also do not provide incentives for an interest rate cut in March.

Another relevant factor causing concerns for American monetary authorities is the escalation in the Red Sea, where new developments arise every week and are already impacting maritime transportation costs. Despite being volatile and beyond the control of monetary policy, they pose an additional challenge in price control.

Therefore, it is important to observe the language that will be adopted in the next communication from the Fed, which may provide clear guidance on when the interest rate cut will occur. If it indeed takes place in March, this signaling is likely to happen in the meeting on January 30-31.

Image 4: US – Earning and Monthly Inflation (%)

Source: Refinitiv

In Summary

The disinflationary process in the United States has increasingly shown signs that it will be successful, meaning bringing prices to the 2% target without leading the economy into a recession, the so-called 'soft landing' often mentioned by the Fed.

However, despite igniting hope in the market, it is not anticipated to occur in March. The robust economic data does not justify an overly premature interest rate cut, as evidenced by the positive GDP growth and the resilient labor market.

If it does occur, a clearer communication in its forward guidance is likely to happen at the end of this month when monetary authorities convene for the first time this year.

Weekly Report — Macro

Written by Victor Arduin
[email protected]
Reviewed by Alef Dias
[email protected]
www.hedgepointglobal.com

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