Fed’s Rate-Cut Signal Next Year Could Prompt a New Bout of Inflation
- The Fed signaled three interest rate cuts for 2024 even though inflation is running above its 2% target.
- Some economists predict a fresh bout of inflation on the impending rate cuts.
- Interest-rate cuts boost demand for loans, spurring investment and spending.
The Federal Reserve on Wednesday signaled three interest rate cuts in 2024, sending the financial markets cheering — the Dow Jones Industrial Index closed at fresh record highs for two straight days, and commodities rallied.
However, some economists worry that the Fed’s signals could prompt another wave of price increases.
As it is, US inflation hasn’t quite reached the Fed’s target rate of 2% — in November, the Consumer Price Inflation rose 3.1% year-over-year.
“The shored-up sentiment among market participants has caused financial conditions to become the loosest they have been during the central bank’s tightening campaign, which is likely to create a renewed bout of inflation,” wrote Jose Torres, a senior economist at Interactive Brokers, in a Thursday note.
He noted that all commodities have risen sharply in anticipation of “re-accelerating inflation” in the months ahead.
“I thought Powell was too early in discussing rate cuts, something he remarked as premature just two weeks ago,” added Torres, referring to Fed Chair Jerome Powell.
“I don’t see how the Fed is going to get inflation down to 2% if they’re going to start cutting interest rates,” Robert Brusca, president of FAO Economics, told MarketWatch on Thursday, adding that robust wage growth was also driving inflation.
But the Fed’s fight against inflation has yielded some results. November’s 3.1% was still slightly lower than October’s print of 3.2%. It was also significantly below the 40-year high of 9.1% in June last year.
The moderation in inflation came after 11 interest rate hikes by the Fed since March 2022 to dampen spending and control price rises. The central bank has held rates steady since July.
Interest rate cuts would bring relief to debtors as they would lower the cost of borrowing for anything from mortgages to credit cards. It would also drive business spending and investments.
However, cutting interest also comes with risks.
After all, if the US economy doesn’t slow to near recessionary growth in the next quarter, “inflation will be higher down the road, and sooner,” wrote Steven Blitz, the Chief US Economist of GlobalData.TSLombard in a Thursday note seen by Business Insider.
Blitz himself does expect weaker economic data in the months ahead to weigh on the US economy. For the Fed, a recession is worse than inflation running higher than 2%
“With their two-to-three-year timeline for inflation to return to 2%, they can be patient,” wrote Blitz. “If there is a negative print on employment, there is no patience, they will cut.”