This week’s U.S. CPI print reminded investors that the path back to 2% inflation probably isn’t a straight line. The reality check may have been needed: heading into the year, markets had been betting on an arguably overexuberant path for rate cuts (at one point calling for about 170 basis points worth of cuts in 2024).
Expectations seem more reasonable today, and looking at the bigger picture, inflation is still trending in the right direction. That’s good news given that Federal Reserve Chair Jerome Powell was clear that we just need to see a continuation rather than an improvement of current inflation trends to get comfortable with rate cuts this year. Each of the three key drivers of inflation – the labor market, shelter and supply chains – are still showing promising signs.
But why would the Fed cut rates at all if the economy is so strong? At today’s levels, policy rates are restrictive. Consider that the real policy rate has actually risen as inflation has decelerated, even though the Fed has stopped hiking. That means that as inflation continues to move lower, central banks need to cut just in order to maintain the same level of restrictiveness. Policymakers are thus tasked with balancing both the risks of inflation reaccelerating and the risk of overtightening. We think 125 basis points worth of rate cuts this year seems reasonable.
