What Forecasters Say About Interest Rates (and Why They Disagree)

What Forecasters Say About Interest Rates (and Why They Disagree)

How soon is soon? Or exactly how much later is later?

At the start of the year, there was widespread belief among economists and on Wall Street that the Federal Reserve would cut interest rates in the first half of the year. Maybe in March, maybe in May, but sooner rather than later.

This long-awaited moment, two years after the Fed began raising interest rates to their highest level in decades, raises the prospect of improving consumer sentiment, higher company valuations and better financing options for companies. It was called “the Pivot Party” and everyone was invited.

But this was followed by three months of inflation data that were above expectations. Financial markets then predicted that the Fed would cut interest rates once, towards the end of the year, or not at all – based on the view that the central bank will see little point in such a move as long as inflation and employment growth remain somewhat elevated.

Interest rates on home and car loans have risen again. And it appears that the pivot party has been canceled. However, some experts argue that it was just a postponement, leaving forecasters divided about what the rest of the year will bring.

Some market analysts and banking economists argue that rate cuts are still on the table. They were buoyed by April’s jobs report, which suggested a slowing labor market and weaker wage growth.

These analysts generally contend that current inflation measures are overstated due to lagging indicators that reflect cost pressures from over a year ago that will ease over the summer. And they believe that the diffuse process of price stabilization, officially called disinflation, may suffer setbacks (particularly an oil shock), but is on the right track.

The Fed’s preferred measure of inflation, the personal consumption expenditures index, rose 2.7 percent on an annual basis in March, well below its peak of 7.1 percent in June 2022. However, progress this year on this measure has been slow and the better-known consumer price index slowed notable, frustrating efforts to meet the Fed’s official 2 percent target.

Skanda Amarnath, executive director of Employ America, a labor market group that tracks inflation data and Fed policy, was initially among those who expected a rate cut in the spring. In a recent newsletter, he said the first quarter was “filled with a number of positive inflation surprises” — from known potential trouble spots like auto insurance to unknown issues like financial advisor management fees — but “that doesn’t mean inflation is disinflationary.” “The process is complete.”

“We are still optimistic,” Mr. Amarnath said, adding that recent inflation deviations “are ultimately marginal” and that “the first rate cut will most likely come in September.”

Research teams at some of Wall Street’s most influential firms also continue to believe in a gradual slowdown in inflation and a series of upcoming interest rate cuts.

On the question of cuts this year, “we remain optimistic about our call for three,” Morgan Stanley’s U.S. research team led by Ellen Zentner said in a note to clients last week — “but we are pushing back the start to September.” .”

Goldman Sachs expects two rate cuts this year – one in July and another in November.

These calls are based on the idea that while the Pivot Party may have been overly exuberant over the winter, recent pessimistic comments have been overblown.

Corporate earnings releases last month showed a number of companies losing sales to inflation-weary customers who have become pickier. But others, fed up with raises or capital gains, pay for more expensive services and goods.

Supply chains and energy markets have stabilized after being rocked by the pandemic and war in Europe, easing some pressure on prices. But the Fed hasn’t “done enough to really kill the consumer to lead to this slower demand-side inflation,” said Lindsey Piegza, chief economist at Stifel Financial, in a recent interview with CNBC.

The inconvenient truth, according to conventional wisdom among financial professionals, is that this period of unusually low layoffs may need to end in order for wage growth and, ultimately, inflation to be fully contained.

“Working conditions remain good – there is no reason to believe that inflation will slow significantly by the end of the year,” argued José Torres, senior economist at Interactive Brokers.

The hot economy, he said, is leading to “structurally higher labor costs” for employers, who are still choosing to respond to those costs with price increases whenever they can. Mr. Torres concludes that this makes the journey to the Fed’s inflation target “almost impossible at this point without a rise in unemployment.”

He doesn’t expect the Fed to start cutting interest rates until next year at the earliest.

Most economists analyzing the data agree that continued willingness to pay for more expensive things (or “price insensitivity”) is partly responsible for persistent inflation.

Torsten Slok, chief economist at Apollo Global Management, has claimed that the upper middle class and wealthiest are fueling prices for services in particular and inflation in general, while several companies report that their lower-income customers are cutting deals and bargaining down to to save.

He predicts there will be little progress on upcoming inflation numbers and that there will be no interest rate cuts from the Fed this year.

“Due to the significant rise in the stock market and significant cash flows” from high-yield savings accounts and bonds, Mr. Slok said in a research note, “U.S. households have more money to travel on planes, stay in hotels and eat at restaurants , attending sporting events, amusement parks and concerts.”

Morningstar, a financial services company, “still expects inflation to essentially return to normal in 2024” and rate cuts to occur by early fall, said Preston Caldwell, the company’s chief U.S. economist.

That call, he said, is based largely on the expectation that government measures on rental inflation – which have been responsible for much of the above-target inflation recently – will soon align with recent private sector readings, which have been milder .

“Current data still strongly points to an inevitable decline in housing inflation,” Mr. Caldwell claimed, “although the exact timing remains somewhat uncertain.”

Assessing the direction of a major item in the consumer price index, the so-called owner-equivalent rent – an estimate of what homeowners, who make up two-thirds of households, would pay if they rented out their homes – has puzzled forecasters. Since the beginning of last year, various experts have been incorrectly guessing when the inflation driver will subside.

Harvard economist Jason Furman characterizes owner rent as “the implicit rent that you owe yourself as a homeowner each month.” This tends to confuse homeowners, particularly those with a fixed mortgage payment, who view their home as an asset rather than a service they provide to themselves. It has become a point of controversy among experts.

In its most recent reading, the consumer price index assumes an inflation rate of 3.5 percent last year. An alternative measure — one used in other major industrialized nations that doesn’t take owner rent into account — suggests that the U.S. economy has hovered just below or above the Fed’s inflation target since June. But virtually no one expects officials to change their chosen inflation measures this cycle.

So there is a wait-and-see attitude and rates remain high in the meantime. And the time sooner or later remains as unclear as ever.

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2024-05-14 07:00:29