Caution and patience for the Fed

Comments by Franck Dixmier , Global CIO Fixed Income at Allianz Global Investors, ahead of the Fed meeting.

• Persistent inflation means we don’t think the Fed is yet able to cut rates.
• But Fed Chair Jerome Powell’s recent comments open the door to easing later in 2024.
• We expect the first rate cut in June once a slowdown in the economy feeds through to lower prices.

Expectations of rate cuts by central banks have been revised sharply downwards since the start of the year and continue to fuel volatility in interest rate markets. But the next meeting of the US Federal Reserve is unlikely to provide investors with any materially new information.

The latest figures published in the US have confirmed that the environment is not conducive to a rate cut at the next Federal Open Market Committee (FOMC) meeting.

Yes, economic activity is slowing. But it continues to show some resilience, particularly in job creation. And inflation continues to put up resistance, remaining at high levels, far from the central bank's 2% target.

Total inflation in February surprised by rising again to 3.2% over one year, compared with +3.1% in January, while underlying inflation was stable month-on-month at +0.4% (as in January, but against +0.3% expected), and down slightly over one year at +3.8% (against +3.9% in January and +3.7% expected[1]). The higher-than-expected producer price figures have reinforced the perception of a disinflation trajectory that is struggling to converge towards the 2% target.

As emphasised at the FOMC press conference[2] in January, the Fed will need to see a couple of good inflation prints to convince itself of the need to cut rates. So we are not there yet.

Against this backdrop, the Fed must maintain a restrictive monetary policy in the short term. But the Fed Chairman's recent comments open the door to policy easing.

Appearing before the US Senate Banking Committee on 7 March, Jerome Powell said that the Fed was approaching the level of confidence required to ensure that prices would move sustainably at 2% to start cutting rates. He added that an interest rate cut would be appropriate during 2024 ("at some point this year").

Therefore, inflation data over the next few weeks will be decisive in validating market expectations, which are tending to postpone a first rate cut until the July meeting.

We believe that the slowdown in the economy, which is already evident in the deterioration in demand (as seen in the latest weaker-than-expected retail sales data), will be a decisive factor in price movements over the next few months, and should enable the Fed to cut rates at the June meeting.

[1] US Labor of Statistics

[2] 31 January 2024

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