Doubts Creep In About a Fed Rate Cut This Year
Traders started the year predicting up to seven rate cuts. Now, many are betting on one or two—or none.
By Eric Wallerstein
After the latest blockbuster jobs report Friday showed continuing strength in the economy, more traders are betting the Fed may cut the benchmark federal-funds rate just once or twice this year, fewer than officials’ last median forecast of three quarter-point cuts.
And a handful are even starting to wager that the central bank will leave rates where they are.
The shift could pose a challenge to a stock-market rally built on the hope that the economy would slow enough for the Fed to lower borrowing costs from multidecade highs above 5%, but not enough to start a recession.
Instead, the prospect of growth and inflation keeping rates far higher than anticipated just months ago has rattled markets, sending the Dow Jones Industrial Average to its worst week since March 2023.
Stocks recovered some ground after Friday’s jobs data, but the blue-chip index finished the week down 2.3%.
“The last of the economic bears are throwing in the towel,” said Joe Brusuelas, chief economist at RSM US.
“We have a sustained economic expansion, and investors who manage risk are now repricing it.”
Investors will get a new perspective on the outlook for rates this coming week with Wednesday’s release of the consumer-price index.
Inflation has cooled significantly from 40-year highs, but two months of hotter-than-expected readings have helped reinforce the Fed’s wait-and-see approach to cuts.
That data will follow a string of signs that U.S. growth is robust.
The country added far more jobs than economists anticipated in March, with workers becoming more productive and immigration continuing to fuel employment.
Prices for oil and other commodities have climbed to multimonth highs.
The housing market remains firm.
Market-based measures of inflation are also now creeping up.
Contracts tied to the CPI show inflation averaging more than 2.5% over the next five years, the highest level since November.
The combination has some Fed officials saying they need to see more before acting.
Minneapolis Fed President Neel Kashkari said last week that the central bank would hold off on cutting rates if inflation doesn’t subside.
Dallas Fed President Lorie Logan said Friday she was concerned that inflation declines might stall and warned that it was “much too soon to think about cutting interest rates.”
That would upend expectations from the turn of the year, when Wall Street was betting on six or seven rate cuts in 2024.
Investors cheered the prospect, scooping up stocks and riskier assets.
Cheaper borrowing makes it easier for companies to access cash, while also increasing stocks’ attractiveness relative to bonds.
The S&P 500 is up 9.1% this year.
Yet as the economy has proved stronger than expected, investors have slowly walked back those bets.
Futures tied to the fed-funds rate show the benchmark rate finishing the year around 4.75%, according to FactSet, above Fed officials’ 4.6% forecast from March.
Those contracts had showed rates ending 2024 below 4% just a few months ago.
Traders have also pared back on bets that would pay off if the Fed swiftly reduced rates, CME FedWatch data show.
Wall Street’s base case is for the central bank to lower rates in June, pushed back from March at the start of 2024.
Fed Chair Jerome Powell said this past week that officials still expect that falling inflation will allow room for cuts this year.
“The Fed can still cut in June and couch it as fine-tuning rather than a dramatic change in the stance of monetary policy,” said Brian Jacobsen, chief economist at Annex Wealth Management.
“But they don’t have to be in a hurry.”
The longer that officials wait, the less likely there will be cuts this year, some analysts said.
That is because officials will likely resist starting to lower rates in the midst of this year’s presidential election campaign to avoid political entanglements.
For now, growth has helped stocks hold near all-time highs even as rate cuts appear less imminent, in part because it fuels gains in companies’ profits.
Analysts are forecasting that companies in the S&P 500 would collectively increase their earnings by roughly 28% through the end of next year.
But if the Fed stands pat—because inflation rebounds or stalls before falling to the Fed’s 2% target—that would be more worrisome.
Another place the Fed and Wall Street diverge is the level where interest rates will ultimately settle.
On Friday, Fed governor Michelle Bowman said controlling inflation in the postpandemic world will likely require higher interest rates than before.
And rate increases still aren’t off the table.
“While it is not my baseline outlook, I continue to see the risk that at a future meeting we may need to increase the policy rate further should progress on inflation stall or even reverse,” she said.
Traders expect rates above 3.85% by the end of 2026, while Fed officials are forecasting 3.1%.
There is a more than one-percentage-point difference between where the market and the Fed see the neutral rate—the long-run level that neither stimulates nor slows the economy.
Ed Al-Hussainy, a rates strategist at Columbia Threadneedle, said he expects Fed officials to continue inching up their neutral-rate forecast, but not as high as traders expect.
Market pricing is also a historically poor indicator for where interest rates will go.
“The Fed overestimated where the neutral rate was for years,” said Al-Hussainy.
“Now, the market is overshooting.
I bet traders will fall closer in line with the Fed’s long-run estimate.”
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