Federal Reserve policymakers are preparing to kick off the new year with compelling evidence that their recent interest rate hike campaign has successfully curbed U.S. inflation. Recent data shows that inflation is now at or below the desired 2% target, a significant milestone that supports the Fed’s decision. This development has garnered optimism among traders, leading them to bet on future borrowing cost reductions by the Fed.
The personal consumption expenditures (PCE) price index declined by 0.1% in November compared to October, marking the first decrease since April 2020. As a result, futures contracts tied to the Fed’s policy rate are pricing in a benchmark rate range of 3.5% to 3.75% by the end of the year, 1.75 percentage points lower than the current level.
While celebrating the more favorable inflation data, it is important to recognize potential turbulence in the first quarter’s inflation readings. Fed officials will likely want to navigate through this turbulence before decisively shifting their focus to rate cuts. Inflation Insights’ Omair Sharif explained, “The Q1 inflation readings may present some challenges, which Fed officials will want to address before fully committing to rate cuts.”
Rate Cuts Timing Debate Looms Amidst Retreating Inflation
During the past month, the Federal Reserve maintained its policy rate within the 5.25% to 5.50% range. Fed Chair Jerome Powell’s latest remarks hinted at a potential pause in the rate-hike campaign and ignited discussions about the optimal timing for rate cuts. Following Friday’s data reaffirming the retreaAet in inflation, experts suggest expediting discussions around rate cuts to ensure that the tightening policy does not inadvertently hinder the cooling labor market, potentially leading to an economic downturn.
KPMG Economics’ Diane Swonk pointed out that caution prevails among Fed officials, as they remain hesitant to quickly implement rate cuts. They fear undoing the progress made in combatting inflation. Therefore, a delicate balance must be achieved to avoid derailing the hard-won fight against inflation while also addressing the need for economic stimulus.