In December 2023, investors, according to the interest-rate futures markets, anticipated up to six interest rate cuts in 2024. Even the Federal Reserve officials’ projections called for two to three cuts. However, here we are halfway through the second quarter and nary an interest rate cut in sight. So how did we get here? Primarily, inflation has proven more resilient than The Terminator!
The Personal Consumption Expenditures Index, which reflects changes in the prices of goods and services purchased by consumers, is up 3.4% in the first quarter 2024, despite economic growth slowing. With inflation coming in at 3.4%, we don’t think that we’ll see those three interest rate cuts this year, as the theme for interest rates has shifted to “higher for longer.” Even the market is now pricing in only one cut.
Gross Domestic Product for the first quarter of 2024 was initially anticipated to be 3.5% but was revised down to 2.4%. When the report was released in late April, growth was 1.6%. When GDP comes in lower than expected, logically, it would be considered “bad news,” and, logically, stocks would sell off while bond yields fall. However, in the current environment, this lower-than-expected economic growth report drove bond yields higher as investors expect this means rates are unlikely to decline as soon or as much as they initially expected. Fourth Quarter 2023’s GDP grew by 3.4%, with the savings rate at 4%. The first quarter’s savings as a percentage of disposable personal income also declined to 3.6%, indicating consumer weakness as well. While spending on goods has declined 0.04%, spending on services is up 4%, bringing overall consumer spending up 2.5%, not adjusted for inflation.
When interest rates move higher, the Fed expects slower economic activity, with the target being 2% inflation. However, with inflation at 3.4%, by the Fed’s preferred measure, and Fed Funds interest rates at 5.5%, most would expect inflation to come down at some point. It is the lingering inflation in the services sector that is worrisome to the Federal Reserve. It was only in early 2021 when rising inflation was supposedly because of supply chain issues that the Fed insisted inflation was “transitory.” Now, supply chain issues have been resolved, and inflation is proving to be sticky. Slowing growth and accelerating inflation raise concerns about stagflation in an economy heavily reliant on consumer spending, which could have significant negative impacts.
In a vacuum, monetary policy looks restrictive, but weigh that against fiscal policy—the use of government spending and tax policies to influence economic conditions, including aggregate demand for goods and services, employment, inflation, and economic growth—and suddenly, monetary policy is still loose. Despite our deficit, few people are talking about fiscal policy right now, which makes a huge difference in economic conditions.
In 2007-2008, when interest rates were at 0%, we didn’t see inflation because fiscal policy was so tight. Since interest rates were left historically low for an extended time, higher inflation was the most expected outcome; however, because of a more restrictive fiscal policy—especially with financial reregulation—our economy never saw inflation.
At 3.4% inflation, is there a case for an interest rate cut? We are still getting some economic growth, albeit slowing; inflation is still present, and the consumer is still spending. Could it be politics? The Fed is not supposed to be political, but solely focused on our economic conditions.
If you have questions on how we account for inflation in your financial plan, the experts at Henssler Financial will be glad to help:
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