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Our views 29 April 2024

US inflation still too strong, but not time to throw in the towel on US rate cuts

5 min read

Late last year, economists (looking at the consensus figures collected by Bloomberg) were expecting around 1.2% GDP growth this year in the US and around 100 basis points (bps) of rate cuts.

Since then, growth forecasts have been revised up substantially and consensus seems to be for 50bps rate cuts and on a trajectory to forecast even fewer cuts.

Activity data OK, while inflation still not target-consistent

Although the Purchasing Managers' Index (PMI) business survey indicators suggested that activity growth slowed in April and the recent first quarter GDP figures were weaker than expected, the picture of underlying domestic demand in the GDP figures was more upbeat than the headline suggests. Meanwhile, both the core Personal Consumption Expenditures Price Index (PCE) and Consumer Price Index (CPI) measures of inflation continue to look stronger than is consistent with sustainably hitting at 2% inflation target. While in my February report I said that a US rate rise couldn’t be ruled out, it was far from my central case of 75bps of rate cuts for 2024. Is it time to swap my central case for that risk scenario? I don’t think so, but 75bps looks too much for a central forecast after recent data.

No urgency for cuts

Fed speakers have made clear in recent weeks that they are in no hurry to cut rates. Why would they be? The data has been telling them that there is no urgency for easing monetary policy. Full year GDP growth looks set to come in stronger than expected at the start of the year. After a strong end to 2023, above 2% GDP growth looks more likely to me than something closer to 1%. Non-farm payrolls growth has been robust. That wouldn’t be enough to stop them cutting rates, but inflation has also surprised on the upside.

Insufficient confidence to cut

As with most central banks, they’ve wanted more evidence/confidence before cutting rates. In March the Federal Open Market Committee (FOMC) statement continued to contain the line: “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.” Although Fed Chair Jerome Powell was able to somewhat brush off the January and February inflation figures, it was evident from Federal Reserve communications that another month of surprising strength in inflation (March) made that harder to do and confidence in the inflation trajectory – so far – is insufficient to cut rates. It seems likely that, unless the activity data take a further sharp downturn from here, the Fed would presumably want to see a few months of inflation target consistent inflation prints before having enough confidence in the overall trajectory to cut rates.

Is inflation stuck?

But is it still sensible to think inflation will fall from here? I think so, yes – especially on core measures. There may be no further downside to come from energy and core goods inflation. However, looking at services inflation ex-energy, it’s still high and I expect it to cool. Pay growth doesn’t look especially high in the US (unlike in Europe) when measured against average productivity growth and desired inflation rates. Just like Europe, lower energy inflation may feed through to lower services inflation with a lag too.

Hurdle high for rate hikes

As for rate hikes, the hurdle seems high when rates are already at restrictive levels. For now, keeping rates on hold for longer would be powerful enough in my view. A large part of the transmission mechanism operates through rate expectations/financial conditions and the pass-through to bond yields/loan rates. Shifting expectations away from substantial rate cuts, and towards keeping rates steady for longer, can itself help reduce inflation pressures. The Fed still cut rates in my central case, rather than not cutting at all, but 50bps later this year and with a significant risk of only 25bps. The inflation data needs to start looking more target-consistent in relatively short order though.

Chart showing inflation data from 2023 and forecasted for 2024 - 2026

Source: LSG DataStream. Forecasts are RLAM.
Note: US policy rate shown is upper end of Fed Funds target range


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