Inflation and Federal Reserve Actions
Since March 2022, the US Federal Reserve has aggressively increased interest rates to combat inflation. Recent data, however, has given rise to optimism about potential rate cuts. The consumer price index (CPI) reported a modest 3% increase from June 2023 to June 2024, the lowest annual rise since March 2021, significantly dropping from the 9% peak in June 2022. On a monthly basis, prices even dipped by 0.1% from May. This trend suggests that inflation is moving closer to the Fed’s 2% target.
Although this data is encouraging, it is not sufficient for the Fed to consider a rate cut in its upcoming meeting at the end of July. However, economists believe it could pave the way for rate cuts in the meetings scheduled for September, November, and December. Bret Kenwell, a US investment analyst at eToro, noted that while the report doesn’t guarantee three rate cuts by year-end, it certainly increases the likelihood of such a scenario. The cooling inflation, combined with recent signs of a softer labor market, supports the justification for a rate cut from the Fed.
Prospects for Future Rate Cuts
As of July, the likelihood of at least three rate cuts of 25 basis points each by the end of 2024 stood at nearly 50%, up significantly from about 15% a month earlier, according to the CME FedWatch Tool. This tool gauges investor sentiment in the fed funds futures market. The Fed has raised its benchmark federal funds rate by 525 basis points over 11 meetings from March 2022 to July 2023. Over the past year, the rates have remained steady as the economy managed to avoid a recession, despite inflation being more persistent than expected and a resilient labor market.
Inflation is now projected to reach the Fed’s 2% target by late 2025. With further evidence of a cooling job market and slowing consumer spending growth, a rate cut in September seems increasingly likely, according to James Knightley, chief international economist at ING. Knightley suggests that Fed Chairman Jerome Powell might use the central bank’s annual conference in August to signal impending rate cuts.
However, not all analysts believe multiple cuts are necessary. David Russell, global head of market strategy at TradeStation, argues that after an initial cut in September, the Fed might not need to cut again before year-end. He cites the relatively low unemployment rate, around 4%, and the continued high number of job openings as reasons for this stance. Russell warns that aggressive easing could potentially unsettle markets.
Additionally, the Fed might be hesitant to make further cuts in November and December due to the US elections. Stephen Pavlick, head of policy at Renaissance Macro Research, points out that if former President Donald Trump were to win in November, his expected policies, such as tariff hikes, tax cuts, and immigration crackdowns, could rekindle inflationary pressures. This would potentially force the Fed to raise rates again, thus questioning the wisdom of cutting rates more aggressively would cause us to raise them again if Trump is elected.
Banking Sector Performance Demonstrate Consumer Spending
Meanwhile, signs of slowing consumer spending and increasing delinquencies have negatively impacted major banks. JPMorgan Chase and Wells Fargo reported declines in adjusted profits, while Citigroup noted sluggish spending on its credit cards. Higher interest rates have benefited these banks over the past two years but are now leading to reduced consumer and business spending due to higher financing costs.
JPMorgan Chase set aside $3.1 billion to cover potentially bad loans, a significant increase from the previous year, as the bank observed rising delinquencies among some Americans. Citigroup also increased its reserves for potential losses. Chris Stanley, the banking industry practice lead at Moody’s, highlighted that higher-for-longer interest rates, persistently high housing prices, softening used vehicle values, and signs of a cooling labor market require focused scrutiny from the banking sector.
Wells Fargo reported that growth in fee-based revenue helped offset declines in net interest income, which fell 9% to $11.9 billion. Average loans decreased to $917 million from $946 million a year earlier, as elevated interest rates discourage borrowing.
Conclusion
The latest inflation data and the Federal Reserve’s potential rate cuts, combined with the news in the banking sector, paint a complex picture of the current economic landscape. While inflation appears to be on track towards the Fed’s target, the central bank remains cautious about further rate cuts. The banking sector is grappling with the impact of higher interest rates on consumer spending and loan delinquencies. Investors and policymakers alike must navigate these intertwined economic dynamics carefully to ensure sustained growth and stability.
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