Will the Fed Cut Rates This Year?

By Dr. Charles Lieberman, Co-founder and CIO

Investors remain convinced that multiple rate cuts by the Fed are still coming in 2024, even as solid economic data ratchets downwards such expectations.  Growth remains rather healthy and there are no signs of recession, nor reasons to think one is coming.  Inflation prospects are the key.  But without clear evidence that inflation is moving towards the Fed’s 2% target, there is simply no justification for the Fed to move policy into a more accommodative stance.  At this point, we think it is a 50-50 bet that any rate cuts are coming this year.  But with such sturdy economic growth, the outlook for corporate profits keeps improving, offsetting the potential disappointment over rates staying higher for longer.

The surprise in the latest employment report is that the economy is capable of sustaining strong economic growth despite a tight labor market.  A year ago, we pointed out that the rapid pace of hiring would soon exhaust the pool of unemployed, reinforcing labor cost pressures.  We did not anticipate that illegal immigration would supply the workers firms were trying to hire.  So, strong hiring was maintained.  With roughly 2.5 million illegal immigrants, even when excluding those too old or young to work, the labor force swelled by roughly twice as much as implied by the nation’s demographic trends.

These unusual labor market dynamics have gained widespread recognition recently, with Fed Chair Powell refocusing market attention on inflation, rather than economic growth.  Normally, such rapid growth would tighten labor markets, adding to labor costs, and elevating inflation.  Instead, those labor cost pressures were offset by the influx of illegal immigration.  It is a strange dynamic that the surge in labor force growth from illegal immigration is enabling rapid economic growth while tempering the upward pressure on labor costs.  Now, it remains to be seen if inflation can moderate further with the economy on such a strong growth path.  It is surely unlikely if illegal immigration were reduced.  But such a change in government policy seems unlikely anytime soon, so policymakers are themselves now less concerned by the pace of growth and more concerned with inflation.  It is possible inflation could continue to moderate despite the economy’s strong growth rate.  But that’s hardly assured.

The Fed has taken a wait and see approach to policy, even as some members favor rate cuts, while others see no need.  But both groups seem inclined to let policy adapt to the incoming data, which is the appropriate approach.  The earlier likelihood of a pre-emptive cut in rates to forestall a recession has diminished, if not evaporated, in the face of above trend growth.  If solid job and GDP growth are sustained for the rest of the year, as seems most likely, rates will be reduced only if inflation moderates closer to 2%.  That doesn’t seem like a good bet to us.  But the stronger economy should support the new upward trend in earnings forecasts. With rates likely to stay higher for longer, while profits rebound along with the stronger economy, the equity market should improve over the balance of the year, but only modestly.  Stock market gains should also continue to broaden out a bit, with value performing a bit better.  This combination also suggests low volatility.  Indeed, the market’s measure of volatility, the VIX, has been at low levels for a while, but it is hard to imagine volatility ever staying low for long in the stock market.  It is an election year, after all, and there are two wars still going on.  Sustaining low volatility is never easy for equities, since it takes very little to get equities to resume their normal roller coaster behavior.  Still, we should enjoy the quiet while we can.  You just never know when the next earthquake will hit, literally and figuratively.

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