Fed statement holds firm on 3 rate cuts in calendar 2024

21 Mar 2024 , 02:05 PM

FED HOLDS ON TO ITS “3 RATE CUTS IN 2024” NARRATIVE

Just a week ahead of the Fed policy statement, the US consumer inflation had come in 10 bps higher at 3.20%. Even ahead of the policy statement, the Fed had already explicitly ruled out any rate cuts in March and, perhaps, in May also, Now the first rate cut looks likely to happen only in June 2024, although the Fed is yet to commit itself to any timetable. In terms of its perspective, the Fed continues to be ambivalent in its guidance; that it would consider the first rate cut in June, subject to the data cooperating. However, the Fed is holding on to its guidance of 3 rate cuts in calendar 2024, although it now looks like a lot of front-ending.

However, there is another interesting trend that emerged from the Fed statement. The dot plot chart indicates that the rate cuts in 2025 have been reduced from 4 rate cuts to just 3 rate cuts. That means; the Fed may experimentally hurry through its 3 rate cuts in the second half of 2024 and then wait through a better part of 2025 to study the impact. Of course, the decision to cut rates in 2024 would also depend largely on inflation showing signs of moving towards 2% and the labour data and the GDP data showing signs of cooling. Fed had embarked on an aggressive rate hike spree; raising Fed rates from the range of 0.00%-0.25% in March 2022 to 5.25%-5.50% in July 2023. However, since July 2023, the Fed has maintained status quo on rates; even hinting that the rate hikes were done and dusted.

FIVE SIGNALS WE GATHERED FROM MARCH 2024 FED STATEMENT

There were some positive reactions post the Fed statement. Both the Dow Jones and the NASDAQ Composite Index were up more than 1% while the 10 year treasuries were lower. Markets are clearly impressed by the Fed commitment of 3 rate cuts in 2024. Here are 6 key points we gathered from the Fed statement issued by Jerome Powell on March 21, 2024.

• The US Federal Reserve on Wednesday held rates steady but still signalled that 3 rates would most likely happen in calendar 2024. Of course, there were no commitment on timelines or a timetable but the 3 rate cuts in 2024 appear to be more a statement of intent. The market is factoring in the first rate cut happening in June 2024.
• In the Fed statement, Jerome Powell also did not commit to any time table for rate cuts, but underlined the view that three rate cuts were likely in 2024. The market is pricing in the first rate cut happening in the June 2024 Fed meet, subject to the data being in sync. However, the Fed did underscore that rate hikes were over in this cycle. That means, rate hikes were ruled out, something the Fed and the CME Fedwatch agreed over.
• On a more cryptic note, the Fed statement also hinted that it was more than willing to hold rates at elevated levels for a longer period of time. However, the dot plot indicates that rate cuts may be more spread out. For instance, the number of rate cuts in 2025 have been reduced from four to three. In addition, the dot plot is pencilling in three more rate cuts in 2025 and two more cuts in 2026, taking the eventual Fed rate to 2.6%.
• For the calendar year 2024, the Fed officials are wary due to higher than expected consumer inflation. PCE inflation has been persistently trending lower, but it is now likely to follow the consumer inflation direction higher. Apparently, the Fed still does not find the inflation data convincing enough that it is eventually moving towards the 2% mark. That was supposed to be the trigger for rate cuts anyways.
• As Fed officials have stated in recent months, the Fed really has the luxury of waiting and watching for longer. For instance, had the series of rate hikes resulted in a hard landing for the US economy, then the Fed would have been forced to cut rates on an urgent basis. However, there is no such compulsion now, and that has given the Fed the luxury to wait and watch the data for longer before taking a call on rate cuts.
• On the balance sheet unwinding program, the Fed has gone slow on reducing its balance sheet as hinted in the January Fed statement. Quantitative tightening had resulted in the bond book already wound down by $1.40 Trillion between mid-2022 and late 2023. The general whiff of the discussion was that it would be appropriate to slow the pace of winding down the book, to avoid any liquidity crunch in the markets.

To sum it up, the markets had three reasons to cheer. Firstly, the Fed reiterated that 3 rate cuts were still on the agenda for 2024. Secondly, the Fed also hinted that the rate hikes were done and dusted. Lastly, the message from the Fed was that it would go slow on quantitative tightening of the bond book to ensure adequate liquidity in the system.

CME FEDWATCH ALIGNED TO 3 RATE CUTS IN CALENDAR 2024

One way to look at the Fed outlook from a market perspective is the CME Fedwatch, which captures the probabilities of various rate levels after each Fed meet over next 1 year. One big question after the minutes is; whether the CME Fedwatch is still reflective of the real story? Here are the CME Fedwatch probabilities after the Fed statement.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
May-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	10.4%	89.6%
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	7.5%	67.4%	25.1%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	3.7%	37.2%	46.4%	12.6%
Sep-24	Nil	Nil	Nil	Nil	Nil	3.0%	30.9%	44.7%	19.1%	2.4%
Nov-24	Nil	Nil	Nil	Nil	1.5%	17.2%	37.9%	31.7%	10.6%	1.2%
Dec-24	Nil	Nil	Nil	1.1%	12.3%	31.5%	33.6%	17.1%	4.1%	0.4%
Jan-25	Nil	Nil	0.6%	7.0%	22.5%	32.6%	24.8%	10.2%	2.1%	0.2%
Mar-25	Nil	0.3%	4.1%	15.5%	28.0%	28.4%	16.8%	5.8%	1.1%	0.1%
Apr-25	0.1%	1.9%	8.8%	20.7%	28.2%	23.6%	12.3%	3.8%	0.6%	Nil
Jun-25	1.1%	5.3%	14.6%	24.3%	25.9%	18.1%	8.1%	2.3%	0.4%	Nil

Data source: CME Fedwatch

The CME Fedwatch is the updated probabilities of Fed rates over the next 10 meetings starting May 2024 and extending all the way to June 2025. In between we have identified the first milestone point as December 2024 (end of current calendar). As of December 2024, there is probability of more than 75% that the Fed cuts rates by 75 basis points. That is 3 rate cuts in year 2024 with the first rate cut happening in June 2024. The CME Fedwatch has just become a little more confident about 3 rate cuts in 2024 after the Fed statement and that is reflected in more decisive probabilities.

The second milestone we have considered is June 2025, which marks the halfway mark for the next calendar year. In the current Feds statement, the 3 rate cuts were maintained for 2024, but the Fed dot plot cut the number of rate cut estimates for 2025 from four to three. As of the latest probability chart, the CME Fedwatch is pencilling in two more rate cuts in the first half of 2025, which means the CME Fedwatch is still sticking to its expectation of 4 rate cuts in 2025, something the Fed had originally committed to. This looks predicated more on the belief that once the Fed embarks on rate cuts, then it is unlikely to slow down the momentum of rates. That is something to watch, considering the oil price pressures.

FED THEME – HIGHER FOR LONGER HITTING US CONSUMERS

Beneath all the arguments for and against rate cuts, the one thing that would really be of concern to the Fed is that the higher for longer strategy is resulting in a clear pressure on the consumer finances in the US. Consumer credit continues to be very costly and that is hitting household budgets. Here is what we read in the Fed statement.

• In terms of consumer borrowing costs, the current decision to hold rates at the current level means that any relief on rates is not coming in the near future. US consumers have been desperately asking for a cut in rates since the borrowing costs, especially for mortgages, credit cards and auto loans, has gone up sharply. The Impact is already visible in slowing home sales in the US in the last few months.
• While there was good news on the growth front, as the hard landing had been avoided, cost of funds remains a battle for US consumers. Most American households have seen their cost of debt go up sharply in the last few months due to persistently high rates. With consumer inflation still 120 bps away from the 2% target, the US consumers are not going to be able to breathe easy in the immediate future.
• What could be the implication for US consumers of the current rate cutting strategy? It is not great news as it implies that there could be a very slow downward drift in savings rates but no material change in borrowing costs for credit cards, auto loans or home equity loans. That would put them in a fix as their net yield on investments will continue to be negative and only worsen by the day.
• The lending rates in the US have gone up sharply in the last 2 years. However, experts apprehend that with rate cuts on the horizon this year, consumers may not see their borrowing costs come down significantly. That is because, the cost of funds for most lenders will continue to be high for some time, so it will take more time because rate cuts can be actually transmitted to the end consumer.
• The real pressure is on credit cards, which are variable rate products. For instance, the average credit card rate increased from 16.34% in March 2022 to nearly 21% as of date, which marks an all-time high. This has resulted in household budget stress and for most people balances are higher and more cardholders are rolling over their debt from month to month. It is estimated that the rates on credit cards will remain above 20% in 2024.
• Mortgage loans are fixed rate and hence stable. However, the observation here is that even in mortgage loans, the impact is visible due to a hit on purchasing power of households. Most US households have been draining their savings for a long time now and that is reflected in lower appetite for new homes.

Most banks in the US are now paying higher rates to attract deposits and that means rate cuts would take longer to reflect on consumer rates.

HOW WILL RBI INTERPRET THE MARCH 2024 FED STATEMENT

RBI implemented its last rate hike in February 2023 and kept rates static in subsequent 6 meetings till February 2024. For the RBI, the problem is not core-inflation; which is sharply down to 3.3% in February. The real problem is food inflation which is still elevated at 8.66% and the uncertainty over energy inflation on account of the evolving situation in the Middle East and West Asia. Hence, RBI is likely to adopt a more inward-looking approach to rates. Its growth preference would still be the overriding theme of its monetary policy.

For the RBI, the rate cuts may still be some time away. There are general elections coming up in May this year and after the newly elected government is formed, the final budget is expected to be presented only in July 2024. It is unlikely that the RBI would explore rate cuts before that. That would give the RBI few more readings of inflation, IIP and GDP growth; apart from Kharif update and the full year current account deficit (CAD). On thing is clear that with GDP robust at over 8%, the RBI would still prefer a pro-growth tilt to its policy approach. For now, it looks like status quo for the RBI also.