Easing the Pressure: The Federal Reserve’s Plan for Gradual Interest Rate Cuts

After the Federal Reserve finished meeting for two days earlier last week, Chairman Powell announced that they would hold interest rates steady. More importantly, he announced that the Fed remained cautiously optimistic that inflation is trending down as they stuck to the path for interest rate cuts to come later in the year. The Chairman conveyed that price pressure will continue to ease, and it will likely be appropriate to start cutting later in 2024.

By a small majority, Federal Reserve committee members stuck to the expectation of three cuts for the remainder of the year. Powell also indicated that slowing the pace of the reduction to the Fed’s bond holdings will come into view “fairly soon.”

There are several important reasons that the Fed is willing to stay on track to reduce the Fed Funds rates from its current 5.25% – 5.50% to a target (based on the dot pattern) of 3 cuts down to 4.50% – 4.25%? Even without a significant reduction below the current annualized rate of inflation of 3% or better, the Fed is inclined to reduce rates and probably sooner due to the following reasons:

Even if inflation climbed to 3.0% or more, the spread between short-term interest rates (1-5 years) at 4.6% and the rate of inflation is too wide. They would like to see short-term rates at or below the rate of inflation. Otherwise, monetary policy is too restrictive and borrowing costs for businesses as and home buyers is punitive.
The Fed believes that the economy is decelerating (slowing down), and they would like to see interest rates less restrictive. While corporate earnings have been well above expectations, growing 3.5% or better since 3Q 2023, companies are beginning to conduct layoffs and gear up for a softening economy. The Fed is aware of this and wants to provide easier credit for the economy.
If the Fed is going to normalize interest rate conditions, they need to do it long before the election in November so as not to look as if they are trying to interfere with the Election and any perceived advantage for one party over another.
The Fed understands that higher interest rates are a material drag on current government debt. Higher interest rates are now responsible for over $1 trillion in finance charges to the Government, exceeding the total defense budget. This is unsustainable.
Interest rates need to come down to bring down the rates offered at the Treasury auctions. Treasury Secretary Yellen has indicated they will suspend some Treasury auctions until such time that interest rates come down as the finance rates on these auctions are egregious.

We have maintained “higher for longer” and will continue with this narrative. Additionally, we are not surprised that some economists have NOT agreed with Chairman Powell’s assessment that rates should be reduced. Former Treasury Secretary Lawrence Summers this week accused the Fed of having “itchy fingers” on rate cuts in the face of a stronger economy.

In summary: We would NOT be surprised if the Fed went to 1 or 2 rate cuts and that they could be put off by a month or two than is currently expected.

US Economy

Firms are raising their selling prices to offset higher labor costs, according to an analyst survey by Morgan Stanley, and the outlook for corporate margins remains solid.
US households are increasingly tapping their IRA/401-k accounts.