It’s a Problem: The Fed Can’t and Won’t Cut Interest Rates

Another FOMC meeting is coming up very soon, and by now, the Federal Reserve should have cut interest rates multiple times. That’s what the market predicted at the start of the year, but it didn’t happen and that’s bad news for large-cap stock index investors.

In just a few months, the prevailing forecast went from six or seven interest-rate cuts in 2024, to maybe two or three, and then to just one or even no cuts this year. It’s basically a done deal that the Fed won’t cut interest rates in May, and the market will desperately look for signals from Federal Reserve Chairman Jerome Powell that the Fed might cut rates in June.

I wouldn’t hold my breath. The core personal consumption expenditures (PCE) price index, which excludes volatile food and energy prices, increased 2.8% year over year in March. That’s the same reading as the one from February, and it’s higher than the economists’ forecast of 2.7% core PCE growth.

It’s a bizarre scenario in which people are spending like there’s no tomorrow but hardly saving anything while the economy contracts. Shockingly, the U.S. gross domestic product (GDP) only grew 1.6% year over year in 2024’s first quarter, versus the economists’ estimate of 2.4% growth.

Courtesy: CNBC

During that same quarter, U.S. consumer spending increased 2.5% year over year. Moreover, the personal savings rate fell to 3.2% in March, down 0.4% from February and down a full 2% from March of 2023.

In other words, the nation isn’t producing as much but people continue to spend like drunken sailors, and that’s what’s propping up the economy for now. Evidently, some Americans aren’t cutting back during this time of sticky inflation, instead choosing to use high-interest-rate credit cards to fund their lifestyles.

What could possibly go wrong? For one thing, Joseph LaVorgna, chief economist at SMBC Nikko Securities, posits that all of this spending activity could perpetuate high inflation. “Just spending a lot of money is creating demand, it’s creating stimulus… Spending numbers aren’t going down anytime soon. So you might have a sticky inflation scenario,” LaVorgna explains.

Another pitfall is that, with the core PCE (the Fed’s preferred inflation gauge) coming in hot, the Fed isn’t in a good position to start cutting interest rates. “For now, it means the Fed’s not going to be cutting, and if [inflation] doesn’t come down, the Fed’s either going to have to hike at some point or keep rates higher for longer,” LaVorgna warned.

Courtesy: CNBC

Despite this mountain of bearish evidence, large-cap stocks continue to march higher in the wake of Big Tech earnings. Huge beats from the likes of Microsoft and Alphabet are evidently enough to lift the spirits of nervous index-fund investors, for now at least.

JPMorgan Chase CEO Jamie Dimon isn’t quite as optimistic as the market appears to be. Looking at the “range of possible outcomes,” Dimon cautions, “You can have that soft landing. I’m a little more worried that it may not be so soft and inflation may not go quite the way people expect.”

Dimon estimated that the markets are pricing in the odds of a soft landing at 70%. In contrast, Dimon stated, “I think it’s half that.” Of course, the odds could change quickly if Powell and the Fed suddenly take a more accommodative tone.

Whether that happens is anybody’s guess. For the immediate term, however, the chance of an interest-rate cut is practically zero. With that, it’s the sensible investor’s role to filter out the noise, diversify, and de-risk against the not-so-soft landing that could come at any given moment.