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What Goes Up…

What Goes Up…

January 18, 2024

This year, the Fed says interest rates will probably start coming down. The question is when.


Most people know the only sure thing in the markets is change. We don’t have absolute knowledge of the future. What we’ve got are rules of thumb and what we like to call “indicators” — signs of one thing that’s likely to happen. When the chair of the Federal Reserve holds a press release at which he says he expects they’ll start lowering interest rates by the end of the year, that can be taken as a fairly significant indicator. That’s exactly what happened in the first week of January.

Jerome Powell made the announcement following a December Fed meeting in which the leaders of America’s central bank agreed that inflation seemed to have come under control and were concerned that “overly restrictive” policy might pose a risk to the economy.

Now, the meeting minutes do contain the phrase “high degree of uncertainty” when describing when and if these lower rates will come into effect. That’s not a phrase that inspires confidence or decisiveness. But those minutes also contained some good hints about what board members were thinking. The magic number seems to be 2%.

For one thing, the minutes said that members intended to keep rates high “until inflation was clearly moving down sustainably’’ toward their target of 2%. For another, a “dot plot” showing individual board members’ expectations showed that they expect cuts over the coming three years to bring the overnight borrowing rate back down near the long-run range of 2% as well.

The meeting minutes also contained this more encouraging phrasing: “In their submitted projections, almost all participants indicated that, reflecting the improvements in their inflation outlooks, their baseline projections implied that a lower target range for the federal funds rate would be appropriate by the end of 2024.”

Currently, the annual inflation rate (as of last November) is 3.14%. But the core personal consumption expenditures price index for the last six months has run just below the Fed's 2% target.


How we got here

In March 2022, the Fed started raising interest rates to combat an unexpected wave of consumer price increases that had been climbing for about a year. Since that initial boost, the Fed raised its benchmark rate another 11 times to a 22-year high of about 5.4%. High inflation and high interest could have triggered a recession, but it didn’t.

Instead, the US gross domestic product grew at a 4.9% rate, and employers added 232,000 jobs a month through November last year. That kept the unemployment rate below 4% for two years, the longest streak since the 1960s.


What else to look for

One warning sign the minutes alluded to was a possible tradeoff between controlling inflation on the one hand and maintaining low unemployment on the other. Powell has previously promised to avoid this kind of robbing-Peter-to-pay-Paul situation. If the unemployment rate starts to rise, the interest-rate outlook might become less rosy.

Until inflation rates approach that magic 2% gateway, the meeting minutes say the Fed’s decisions would be "careful and data-dependent."  The next Fed meeting is on January 30-31, so expect to get a better idea of what’s to come by the beginning of February. Until then, we can keep an eye on indicators in that data and follow our best rules of thumb.