December 15, 2023 | The Federal Reserve Makes a Full Pivot To Rate Cuts

The Federal Reserve announced a pivot to rate cuts, hinting at an end to the period since March 2022 of rate increases and tightening of financial conditions.

When the Fed cuts rates, will it help?

The Fed meeting ended on Wednesday with chair Jerome Powell confirming the consensus view — the next Fed move will be a cut in rates.

This is a major shift in policy.

Starting in March 2022 the Fed increased rates from essentially zero to a range of 5.25 to 5.50 percent, a level reached in July 2023. The Fed then went on hold.

And this week the Fed is still on hold, but Powell threw a bone to traders, hinting there will be rate cuts of about 50 basis points in 2024. This was music to their ears, and they moved aggressively to get invested in stocks and bonds.

On Tuesday the U.S. CPI showed further progress in getting inflation under control, with a core reading of 0.1 percent month-over-month and 3.1 percent from a year ago.

The Fed inflation target is 2 percent, so the CPI is within 1.1 points of that target. Actually, the Fed uses another indicator — the PCE or personal consumption expenditure — which has also been moderating, at 3.5 percent to 3 percent for several months.

So, the Fed could sit back and wait for the CPI and PCE to drift down to 2.0 percent and declare victory. It seems that the target could be reached soon if current trends continue.

But the largest component, shelter, has been sticky, and that sub-index has not come down as fast as headline CPI. Shelter cost increases peaked at 8.2 percent in March and declined to 6.5 percent in November. But those numbers are annual percentage gains, while what really matters to people is the current cost of shelter. Without actual deflation in house prices and rents, people are paying much higher amounts for shelter.

For example, the U.S. CPI shelter sub-index was 313 in January 2019 and sits at 388 in November 2023. That is a total gain of 24 percent.

Without actual deflation in the cost of shelter, gasoline and food, the average person will not be impressed when the Fed reaches its 2 percent target, even if that comes early next year. And 50 basis points of cuts to 4.75 percent won’t be enough.

The Fed will pivot to interest rate cuts before deflation arrives for key goods and services such as shelter. The central bank will cut as soon as there’s any sign of a severe recession, as it tries to get ahead of a jump in unemployment.

However, modest interest rate cuts will not help the average worker who has just lost a job or is looking at fewer hours as shifts are cut back.

And that wage earner is still facing shelter, food and energy costs that are stuck at substantially higher levels without seeing matching wage gains. Lower interest rates won’t change that reality.

Hilliard MacBeth

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Hilliard MacBeth December 15th, 2023

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