• Fed holds overnight rate range steady at 5.25% – 5.5%.
• Retains assessment that “the economic outlook is uncertain.”
• No cuts until “greater confidence that inflation moving toward 2% goal.”
• Rate cuts pushed further into the future.

Still not enough

The mantra “Higher for Longer” has reverberated around Wall Street for most of this year. It is as much a term of fear and derision as fact. Wall Street wants lower interest rates for a variety of reasons. Two important reasons for our clients are home mortgage rates and loan rates for businesses. A steady economy at near full employment, stock markets near highs and easy financial conditions mean higher rates are not slowing the economy enough for the Fed to reverse course and begin cutting rates.

Fed members have repeatedly stated that current policy is restrictive and should be slowing the economy meaningfully. A slowing economy means lower job growth, more layoffs and falling wage inflation. That, in turn, should bring down the consumer price index. At least that is the Fed’s thinking. Since wage inflation is running north of 4%, we would suggest the moderation in inflation is due more to consumers tightening their wallets than job layoffs.

Inflation is driven by more dollars in circulation chasing the same or fewer amount of goods and by temporary outside shocks. Excess dollar supply comes from the Fed printing money for the administration’s deficit spending. Financial conditions refer to the amount of money in the banking system, stock, bond and commodity prices, and other metrics. The shutdown and restart of economies around the world four years ago resulted in classic recession supply price increases. The amount of liquidity from financing deficit spending is about the only thing the Fed can control, other than short-term rates. By not lowering rates for most of this year, they have slightly tightened financial conditions as the difference between short-term rates and falling inflation increases. 

Forecasts

Fed committee members and Wall Street came into the year expecting between 3 and 4 quarter-point rate cuts. Persistent 3%-plus inflation numbers have led Committee members in speeches to talk about fewer rate cuts.

Today’s quarterly update of Fed forecasts showed that Fed members are following the data, not Wall Street wishes. Since inflation readings are not running back down to 2%, there is less need to cut rates in their view. The number of Committee members thinking only one cut may be needed this year increased from four to seven. The median number of cuts forecasted by the Committee for this year moved from three to one. Still, eight of the 19 members believed two cuts may be necessary. They also marked up their inflation forecast for this year from an interesting 2.4% to still-tough-to-reach 2.6%.

Economic projections were left unchanged, the Fed believing the economy will grow at 2.1% this year and 2% in 2025. We hope they are low.
 

Analysis

Inflation, or the speed of change in prices, has meaningfully slowed. The May 2023 reading of the consumer price index showed prices running at 4% growth. This morning’s report for May 2024 showed prices creeping higher at a slower rate, averaging 3.3%. For the rate of change to fall, individual prices in the basket of surveyed goods must fall. Prices of goods have dropped for six of the past 12 months. The problem for the Fed, and most of us, is that the prices for housing and services continue to rise. Healthcare costs, new and used cars and insurance have all contributed to the CPI staying higher than anyone wants. Gasoline dropping 11% from late April into May helped bring down the headline number. Gasoline prices have dropped another 5% this month. 

Summary

After May’s FOMC meeting, we pointed out that the Fed has never been successful in beating inflation by leaving rates alone. The Fed is trying to guide markets to fewer rate cuts further down the road. We stand by our idea that this second-gear economy with now-average job growth does not need rate cuts to fuel faster growth. Nor is a recession in the cards this year given the amount of government spending in an election year.

Today’s positive reaction in both stock and bond markets is more a function of the May CPI reading holding steady from April than Fed members calling for fewer rate hikes. If the CPI did not come out today, we would expect the Fed’s fewer rate cuts report to have a negative impact on stocks.

Please let us know how we can help you.

Steve Orr is the Managing Director and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. Steve has earned the right to use the Chartered Financial Analyst and Chartered Market Technician designations. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary’s University School of Law. Follow him on Twitter here. 

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