Fed Unlikely to Cut Interest Rates in March, but What About May?

Ivanna Hampton: An interest-rate cut in March is looking less likely. Federal Reserve Chair Jerome Powell says the committee is confident about where inflation is headed. However, it wants to see more good data before starting down a new path. Preston Caldwell is a senior U.S. economist for Morningstar Research Services.

Thanks for joining me, Preston.

Preston Caldwell: Thanks for having me, Ivanna.

Hampton: Now, you have forecast that the Fed would start cutting rates in March. What’s your outlook following Powell’s news conference?

Caldwell: Yeah. So, previously I had the Fed cutting in March, and then I thought they would skip in May and then cut in every other meeting the rest of the year. So, right now, I do think that the odds have shifted slightly toward the first cut being in May. And then if they continue to cut in every meeting for the remainder of the year, then that leaves our end-of-year forecast unchanged. So, it’s not really a big change, but I do think the timing has shifted a little bit.

It’s interesting, it wasn’t until about 40 minutes into the press conference almost that Powell gave his clearest statement about what the Fed is likely to do in March, saying that a rate cut was not the base case. I’m not even sure if he intended to deliver that remark, but nonetheless it came out, and I have to take it as the best indication right now of what the committee will do. Although, keep in mind, a lot more data will come out between now and the March meeting, and that could shift the committee’s decision-making. And in our view, there will be continued progress on bringing inflation down. So, there is still a decent possibility, let’s say a third or more, that the Fed will actually cut in March, but probably May is the most likely. And I think by May the inflation data really will leave no room for doubt that it’s time to start cutting rates.

Hampton: And a follow-up to that, are you still thinking six interest-rate cuts for 2024?

Caldwell: Yes. Because I had originally a skip penciled in for May, if they start cutting in May, then we’ll still get in six cuts through the end of the year, which will take the target range for the federal-funds rate to 3.75% to 4.00%. So down 150 basis points from where we’re at right now. And then we continue to think that the Fed will cut further going into 2025 and early 2026, ultimately bringing the federal-funds rate down to 1.75% to 2.00% as a target range, which would be roughly in line with prepandemic levels.

Hampton: The Fed has called the current interest-rate range “the peak.” Can you describe if there are any benefits or risks to the economy with rates in this range?

Caldwell: With rates in this range, the federal-funds rate and interest rates as a whole are at restrictive levels, and so that means they’re at levels designed to cool off economic activity and thereby bring inflation back to the Fed’s 2% target. So, the ultimate goal is to bring inflation back to normal. However, the longer that rates are kept at a high level, the more downside risk there is to economic activity. Once the inflation has assured its goal on the inflation front, it then wants to switch to propping up economic activity in order to assure its other main mandate of creating full employment. So once the inflation goal is reached, then it will be time to manage risks on the economic activity/full employment front and, yes, there are risks and those can be hard to anticipate.

As the Fed, as Powell noted today, if the Fed waits until the economy begins slowing down to start cutting rates, it could be too late because of the lags in monetary policy. So, it needs to stay ahead of the economy and how it calibrates rates. And nobody knows exactly what the vulnerabilities are of the economy to high interest rates. There could be much more effects in the pipeline, and we think that there could be, which is why it is a sagacious decision for the Fed to begin cutting rates sooner rather than later. But that could turn out not to be the case. The economy could be more resilient to higher rates. But hopefully, the Fed will foreclose any of those risks playing out by cutting rates in an expeditious manner.

Hampton: What do you think the Fed needs to see in the data before declaring the economy has made a so-called “soft landing”?

Caldwell: It’s interesting, in the last six months, core PCE inflation, that’s the main index the Fed looks at, came in at 1.9% annualized. So, in the last six months, if we just zoom into that, we’ve hit the Fed’s 2% inflation target. But on a 12-month or what we call “year-over-year” basis, it’s still at 2.9% because we had higher inflation in the first half of 2023. Once that rolls off, if we continue to have the monthly data rolling in at a 2% inflation rate, then that year-over-year number will continue to glide back down to 2%. So, I think that’s what the Fed is looking for is really the year-over-year or 12-month number getting back to 2%, which will be the case if inflation continues at its current trend and will be the case if our forecast plays out. And the Fed is just going to wait for that. And I think based on our forecast, that will happen sometime in the second quarter with that year-over-year number getting right back to 2%. And that will be—I think by the May meeting in particular, the data will be at about 2.3% year-over-year because they’ll have the March data to work with when they’re doing their May meeting, and that will be enough for them to start cutting.

Hampton: Well, Preston, thank you for your time today.

Caldwell: Thanks, Ivanna.

Watch “2024 Outlook for the Stock Market and Economy” for more from Preston Caldwell.