Inflation: Here to Stay in the U.S?

The U.S. Federal Reserve has decided to keep interest rates steady within the policy range of 5.25%-5.50% due to “lack of further progress” on inflation. 

While Fed Chair Jerome Powell signalled that further interest rate hike is highly unlikely, the latest decision further extends the grip of the current rate which has been in place since July last year.

In addition, the Fed said it is planning to slow down the pace of quantitative tightening 1st June onwards. 

• The Fed will reduce the monthly cap on maturing Treasury redemptions from $60 billion to $25 billion.

• Meanwhile, the cap on mortgage-backed securities (MBS) remains at $35 billion. 

Treasury yields dropped during Powell's press conference, with the 10-year yield dipping below 4.6% before rebounding slightly.

The Fed began to raise rates two years ago in the face of rising inflation and today, it stands at a 23-year high for the sixth consecutive meeting.

Fed officials hinted that they would lower the interest rates once the government can substantially control the inflation and bring it down to the target of 2%.

The latest figures on inflation, the annual rate of inflation being above 3%, don’t give the Fed any reassurance for now to cut down interest rates. It will “take longer than previously expected” for the Fed to take the much-anticipated step.

Powell didn't give any indication of a rate cut this year, given the economic situation in the U.S. The Fed’s further decisions will depend on the evolving situation of the economy of the country.

The observers are expecting only one rate cut this year instead of two. 

Seema Shah, chief global strategist at Principal Asset Management, reacted to the decision, 

"[The Fed's] admission that there has been a lack of further progress confirms that imminent rate cuts are extremely unlikely. A pivot this year will require not just inflation stabilization, but convincing and durable evidence that the disinflation trend is back in play."  

What The Metrics Say...

It was only the last week that the Bureau of Economic Analysis (BEA) released the Gross Domestic Product (GDP) data for the first quarter of 2024. 

Source: BEA

• Real GDP increased at an annual rate of 1.6% during Q1 2024. It was the weakest pace of growth since the second quarter of 2022.

   

• The figure is substantially lower than the one during Q4 2023 when it stood at 3.4%.

• The BEA attributed the drop to reflected decelerations in consumer spending, exports, state and local government spending and a downturn in federal government spending. 
   

It seems that the consumers are being cautious while they are spending, given the high interest rate and inflation.

As far as unemployment in the U.S. is concerned, the unemployment rate has remained high within the range of 3.7%-3.9% during Q1 2024. 

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Source: Bureau of Statistics

In fact, the unemployment rate in the U.S. has remarkably remained below 4% for the last two years.

"The delay in rate cuts will continue to affect the discretionary budgets of lower- and middle-income consumers. ... Costs for daily goods and services like food and gas are still significantly higher when compared to pre-pandemic levels, keeping pressure on Americans’ bank accounts," said Stephen Rich, chief executive at Mutual of America Capital Management. 
 

How Did the Markets Perform?

The stock market in the US surged marginally following the Fed’s announcement.

• The blue-chip Dow Jones Industrial Average surged around 500 points or 1.3%.

   

Source: CNBC/Dow Jones 

• The S&P 500 surged 0.1%.

   

Source: CNBC/S&P500

• The tech-focused Nasdaq surged 1.5%. 

   

Source: CNBC/Nasdaq

• In contrast, Bitcoin (BTC) fell more than 5% to $57k following the announcement. It marked its worst monthly performance since April 2022. 

Source: CNBC/Bitcoin

Traders are keen to keep the markets running high, but the stocks weren't as receptive and soon fluttered.

However, we have seen the markets performing exceedingly well even as other metrics such as GDP, unemployment etc. are not positive.

Prospects of a Rate Cut?

Remember that once the Coronavirus-induced lockdown ended in 2022, job openings were remarkably high as the demand for workforce surged quickly.

The workers are still demanding wage hikes and the job market doesn't seem stagnant. This makes a lot of observers rather optimistic of the economic situation turning positive a few months later.

Note that the Fed instituted a zero-interest rate policy to stimulate the national economy in the wake of the 2008 financial crisis.

The high growth led to an economic bubble and 2023 witnessed the banking crisis hit the national economy.

In conclusion, there are a number of factors such as inflation, GDP, labour dynamics and broader geo-political conditions that will lie at the back of the Fed’s mind as and when it contemplates containing the federal interest rates.