Feb 6 / Alef Dias

Macroeconomics Weekly Report - 2024 02 06

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When will the Fed cut interest rates?

  • Last week, the first 2024 Fed meeting took place, a widely anticipated event in the market seeking clues as to when there will be an interest rate cut in the world's largest economy.
  • For now, nothing changes. The FOMC decided to keep the interest rate unchanged, and there was no official communication, the forward guidance, that monetary policy easing could occur in March.
  • The challenge, therefore, is to understand what is missing for the American central bank to have the necessary confidence to start cutting the interest rate. Let’s check in details some indicatiors to understand it.

Introduction

Despite the great market expectations surrounding the Fed's first meeting in 2024, there is still no clear communication regarding the onset of monetary easing. And if we rely on economic data, as is constantly emphasized in the speeches of the organization's chairman, Jerome Powell, there is no reason for such an early start.

In this regard, what signals need to be observed by FOMC members for the beginning of an interest rate easing in the world's largest economy? This will be the central point of analysis in this report, but an important development in the US Treasury bond market will also be highlighted.

Image 1: US – CPI Inflation (%)


             Source: U.S. Bureau of Labor Statistics

Image 2:   US – Unemployment Rate and Nonfarm Payrolls Earnings (%)

Source: Refinitiv, Bureau of Labor Statistics

The labor market situation doesn't warrant a rush to cut interest rates

The resilient labor market remains one of the biggest concerns for the country's monetary authorities. An example of this is that in the first month of the year, 353,000 jobs were added, surpassing expectations. With robust economic activity and wage gains above inflation, there are no incentives for such a rapid interest rate cut in the economy, and the Fed will need to observe a cooling off of these numbers.

Despite the importance of the economy, there are more reasons for a more cautious approach to interest rate cuts. Inflation remains above the target, and while the decline in energy costs in 2023 helped reduce prices significantly, the pace of improvement in the inflationary outlook for 2024 may not be as fast. It is safer to leave the effects of restrictive monetary policy on the economy for a little longer

Image 3: US – Total Nonfarm Payrolls (Thousand)

Source: Bloomberg

However, the market has already begun to price in a scenario of interest rate cuts for this year, something that can be observed through the yields of 2, 5, and 10-year bonds (T-notes). If a reduction in yields is the natural path due to monetary policy easing, this trajectory will be accompanied by a lot of volatility and supportive fundamentals.

The government finances its activities essentially through two mechanisms: tax collection and debt issuance. As the United States is recording larger deficits, the pressure for the issuance of more Treasury bonds is increasing. The fiscal imbalance brings a premium to the bonds, a fundamental that will be present this year, despite the fall in interest rates.

Image 4: US – Treasury Yields and Fed Funds Target(%)

Source: Refinitiv

In Summary

It's highly unlikely that there won't be an interest rate cut in 2024. The inflationary environment, although still posing risks, has improved significantly in recent months, and the market is already pricing in a less restrictive monetary scenario on the horizon.

However, there will be a significant impact when the monetary policy easing occurs, and there are risks in lowering rates too early. A resilient labor market and strong economic activity are examples that it's not yet time for a rate cut.

In the coming months, there should be an improvement in inflation, but with possible negative surprises from price components that may be under pressure, such as services and goods. However, this will bring more volatility than a change in the basis scenario, that is, the cut in interest rates for this year.

Weekly Report — Macro

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

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