The Weekly (3/22)

Some hikers believe the last mile of a journey is the hardest part: you’re worn thin, hungry, your calves are burning, and the blister on your heel is burning through your wool socks. 

Others might argue that the last mile is the easiest: the finish line is in sight and you’re eager to accomplish the goal you set out to achieve from the start.

For the Federal Reserve, the last mile of the trek towards equilibrium has been a combination of those two feelings. 

It’s been easy in the sense that the Fed hasn’t had to move interest rates for eight straight months which was once again confirmed at this week’s FOMC meeting. 

But it’s been hard in that inflation has not come down as fast as Fed officials would like to see. 

The plan over the last year or so has been fairly straightforward: the Federal Reserve should cut interest rates by 25 basis points (or 0.25%) three-times in 2024. Inflation’s slow decline and the economy’s continued strength (think: sturdy unemployment, a strong labor market, and impressive GDP, among others) have fueled debate about whether the Fed might chart a more aggressive course of action. So the big question heading into the Fed’s meeting on Wednesday was whether they may walk back the expectation of three interest rate cuts.

Following the meeting, however, Fed officials didn’t deviate from their original plans. In fact, the committee’s conviction has only become stronger. In December, six FOMC members believed that three cuts would be the appropriate path of policy for the year. Fast forward to today and nine members have that as their base case.

But why is the Fed sticking to the plan when inflation seems to be rearing its ugly head? 

An important gap in inflation measures helps explain the Fed’s rationale.

The ‘persistent inflation’ narrative has largely been driven by January and February’s Core CPI prints. Rising at a monthly rate of ~0.4% would lead to annual inflation of ~5% if sustained for the entire year, a number that is unacceptable over the long-run.

Core PCE prices, or the personal consumption expenditures index, have been better behaved. Although the preferred inflation gauge heated up in January, their annualized pace over the past half-year has been right in line with the Fed’s 2% inflation target.

The 3% difference between the two indexes is important and is likely helping the narrative for rate cuts.

Although inflation has been ‘bumpy’, the Fed’s recent commentary has been positive for most asset classes. Markets function as a forward looking mechanism and there’s no doubt that higher interest rates are reducing consumption and business investment. A change in rates could reinvigorate corners of the economy that have slowed down, sending valuations higher.

The Fed is approaching its last mile and the question remains: will it be its most difficult or will they cruise to the top?

Have a great weekend,

– Your Titan team 

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