The US economy experienced a significant slowdown in the first quarter, while inflationary pressures intensified. This has greatly dampened market expectations for an interest rate cut by the Federal Reserve, also known as the “Fed”. In an article written by Nick Timiraos, a journalist for The Wall Street Journal, it is stated that the Fed’s hopes for rate cuts this year are gradually fading.
The US Department of Commerce released the latest data on the 25th, which showed that the initial estimate of the annualized quarterly GDP growth rate for the first quarter of this year was only 1.6%. However, the core Personal Consumption Expenditures (PCE) price index increased by 3.7% on a yearly basis, marking the highest growth rate in a year and exceeding market expectations. This indicates unexpected economic weakness accompanied by persistent high inflation.
The article points out that although individual economic growth and price index data so far are not enough to significantly change the Fed’s policy outlook, the cumulative effect of a series of disappointing data is quite significant. In particular, inflation data has consistently exceeded expectations and recent months’ data has been revised upwards in subsequent reports. This trend is causing investors and officials to rethink whether rate cuts this year are appropriate.
Regarding the prospects for rate cuts, Chicago Fed President Austan Goolsbee stated last week that the US Department of Commerce will release the PCE price index for personal consumption expenditure in March. Thursday’s data indicated that inflation in January and February may have been revised upwards from already strong levels, and inflation in March may not have eased but instead increased, thereby maintaining the inflation rate at around 2.8% for the past 12 months.
The Fed’s inflation target is 2%. Since the end of last year, officials have repeatedly hinted at the possibility of starting rate cuts as they expected a slowdown in price increases later this year to around 2.5% and later dropping to 2%. In the third and fourth quarters of last year, the core PCE price index maintained a yearly growth rate of 2%, which supported market optimism that the Fed may have won the battle against inflation.
Kevin Burgett, an analyst at LH Meyer, initially predicted that the Fed would start rate cuts in June and cut rates three times this year. However, after the release of the US first-quarter economic data, he now expects the Fed to only cut rates once at the December meeting this year. Market participants generally agree with this argument. At the beginning of this year, investors in the interest rate futures market expected six rate cuts, but now many expect only one rate cut or no rate cuts at all. Bond investors sold US bonds on Thursday, causing the yield on 10-year Treasury bonds to rise above 4.7%, the highest level since November last year when Fed officials had not yet indicated the end of rate hikes.
Recently, the Federal Reserve has been particularly concerned about monthly inflation data, partly because since the pandemic, central bank economists and the broader economic community have found it difficult to predict inflation. Many people failed to predict the increase in inflation in 2021 and 2022, and were surprised by the speed at which last year’s inflation rate declined amid strong hiring and spending.