The Federal Reserve signaled a softening stance at their December meeting. The messaging at the meeting was a stark change in tone from previous meetings. Economic indicators have continued to trend in a direction consistent with moderating inflation. Both equity and bond markets rallied in response to the meeting, driving equity markets higher and bond yields rapidly lower.
Expectations for lower rates were rather consistent. 17 of 19 Federal Reserve Board governors see rates lower by the end of 2024, while none predict they will be higher. On average, Federal Reserve governors expect three 0.25% rate cuts in 2024. In the December meeting, the average estimate of rates at the end of 2024 was 4.6%, down from an average prediction of 5.1% in the September meeting and lower than today’s federal funds target rate range, which is currently set between 5.25% and 5.5%.
Slowing Inflation
In Powell’s own words: “Inflation has eased from its highs, and this has come without a significant increase in unemployment — that’s very good news. ” The Consumer Price Index, the most common gauge of inflation, fell to a 3.1% increase over the previous year, well below the peak seen last summer when prices were up over 9% year-over-year. This is approaching the 2% target set by the Federal Reserve. Falling oil prices and shipping costs have contributed to easing supply chains and falling inflation alike.
Moderating Labor Markets and Consumer Spending
Meanwhile, the consumer and employment picture remains strong, although slowing enough to support the possibility of interest rate cuts. The most recent employment figures still represent a strong job market, but one that is moderating. Hourly earnings, an important driver of inflation, rose 4% year over year in October. This is still strong wage growth and higher than the Fed’s 3% target; it has been falling steadily since mid-2022 when wages were growing close to 6%. Unemployment has remained persistently low, but the 199,000 growth in jobs last month was below the monthly average of 240,000 over the previous 12 months. Strong labor markets have helped bolster consumer spending. Black Friday sales figures showed growth over the previous year of 7.5%, but still down from the white-hot spending climate of 2022 when Black Friday sales grew by over 12% from a year earlier. Again, consumer spending is a story of slowing demand but not a collapse in spending. With economic indicators largely telling a story of moderate slowing within the economy while avoiding a large uptick in the unemployment rate, the Federal Reserve is looking like it may achieve its sought-after soft landing.
The Impact of Rate Cuts
When rates are cut, it can spur economic activity and support gains in both equity and fixed-income markets. As bond yields fall, bond prices rise, and we have witnessed a historic fall in bond yields since October. The 10-year treasury yield briefly peaked above 5% in October. It has fallen below 4% today, a rapid decline in long-term yields fueling gains for bond portfolios. Companies and consumers alike benefit from less expensive borrowing. Lower rates help companies invest in expansion and, mergers and acquisitions. Investing in projects that will yield profits in the future becomes economically more feasible when the debt to finance upfront costs is less expensive. For consumers, it helps them pay less on credit card debt and finance new cars, new homes, and other spending.
Balancing Inflation and Economic Growth
While both rate increases and rate cuts take time to work their way through the economy, it looks like now more than ever, the Federal Reserve has both avoided a deep recession while taming inflation. The battle against inflation is not yet over, and conditions will continue to fluctuate, but the last Federal Reserve Board meeting in 2023 represents remarkable progress and a turning point in monetary policy.
