FED and Currency

Equity markets bounced last week, partly on news that inflation continues to slow. That is persuading a growing number of money managers that the U.S. Federal Reserve will begin cutting interest rates this year.

The Fed itself is not so sure.

Several Fed officials have said the central bank “has a long way to go” to drag inflation back to its 2-percent target.

U.S. consumer prices rose 6.5 percent last month, its sixth straight month of diminishing increases and the smallest gain since October 2021, but still more than triple the Fed’s target. (See “Inflation Continued to Slow in December” in this issue.)

Still, interest-rate derivatives traders have put the chance of a quarter-point hike in February at 90 percent and raise rates two more times before April to around 4.9 percent. Players see 60-percent odds that the central bank will begin to cut rates at least once later this year.

In contrast, last month Fed officials in the bank’s rate-setting committee projected interest rates will peak around 5.1 percent. None mentioned a likelihood of cutting rates.

Why are markets more cheery than the Fed, which ultimately will determine the outcome?

“I don’t know why markets are so optimistic about inflation,” Mary Daly, president of the Federal Reserve Bank of San Francisco, said last month after the committee met.

While markets are focused on inflation’s demise, the Fed is placing equal emphasis on the labor market: if wages continue to rise, that will pressure prices upward and sustain inflation longer.

“It could be that inflation starts to go in the other direction again and the Fed would have to react to that,” St. Louis Federal Reserve Bank president James Bullard said in a 12 January comment quoted by The Wall Street Journal.

“I don’t think there’s enough pricing being put on that possibility,” he said.

Indeed, “the market…thinks inflation is going to fall much faster than the Fed does,” Mark Cabana, Bank of America’s chief interest-rate strategist, told the WSJ.

Part of the difference is explained by the two using different methods, the WSJ pointed out.

Fed officials project their reaction to the economy’s most likely behavior. In contrast, market players can make weighted bets on a variety of scenarios.

Also, “the market has learned that forward guidance for central banks…doesn’t hold much credibility,” chief global strategist Sam Lynton-Brown at BNP Paribas commented to the WSJ.

The difference between market expectations and the Fed’s more dour statements stems, in part, from Fed officials’ understanding that their words can too easily move markets. As a result, they tend to be more circumspect and conservative in their public comments, the WSJ noted.

“The minute the Fed acknowledges inflation isn’t a problem anymore, markets will speed higher,” which could accelerate inflation once again, portfolio manager Jack McIntyre at Brandywine Global said in a WSJ interview.

TREND FORECAST: Barring unexpected events in the next two weeks, the Fed will add a quarter-point to its key interest rate when it meets on 1 February.

Betting that the Fed will cut its rate any time this year is pure speculation. As we see it, Inflation would need to fall below 5 percent and stay there for at least two months before the central bank would even begin to envision any rate cut. However, considering that 1 percent rule the economic world, they may well pressure the Banksters to lower interest rates so they can boost up their profits. 

Remember! When equities were tanking in December 2018, then President Donald Trump hounded Fed Head Jerome Powell to lower interest rates… which he did.

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