Smart Investing

The Case for No Rate Cuts This Year

Federal Reserve - Shutterstock photo
Credit: Shutterstock

There is a growing view among market watchers that there may not be any rate cuts this year, or at least not until the fourth quarter at the earliest. At the start of the year, that seemed like a preposterous idea. The only debate back then was whether there would be six or seven cuts, and whether they would begin in March or a little later, but things have changed.

Inflation has proven to be stubborn, something that will have come as no shock to those who lived through the 1970s and 80s, but seems to have taken a lot of people by surprise this year. The notion of no cuts at all in the immediate future is growing as the data suggests that inflation isn't declining in the way we had hoped, but there is an argument that no cuts this year is not just possible but actually desirable.

Inflation, as measured by the Fed’s preferred metric, Core Personal Consumption Expenditure (PCE), dropped quickly to 2.9% in December of 2023, but progress since has been slow, with the metric showing 2.8% annual growth in the last report. In addition, the jobs market remains tight, consumer spending is outstripping expectations, and commodity prices are elevated, all of which indicates that it isn’t about to fall any time soon.

Fed Chair Jerome Powell acknowledged all of that in a speech this week, when he gave his biggest hint yet that cuts are effectively delayed indefinitely, saying, “We can maintain the current level of restriction for as long as needed.” The market took those words pretty much in its stride yesterday, with the S&P 500 posting a small loss, but nothing like what the airing of such a notion would have caused a short time ago.

Traders and investors are obviously coming to terms with the Fed Funds rate remaining at or around its current 5.0-5.25% target and they clearly believe the numbers that show that the economy is dealing with that level without any major ill effects.

That is the main argument as to why a delay in cutting rates is not a bad thing, but it can be taken a step further. An argument can be made that maintaining current interest rate levels is a good thing and may even be necessary to restore economic stability.

That argument rests on the assertion that it is not 5% interest that is the anomaly, it is the dozen years beforehand that was the anomaly, if looked at on a historic basis: The Fed Funds rate averaged 5.42% since 1971.

Low rates were instituted starting in 2010 for good reason. The 2008/9 recession was prompted by a liquidity crunch, and promoting the free flow of money through low rates was essential if we were to move on from that. However, once the idea of ultra-low rates caught on, businesses and markets quickly came to see them as normal, and reacted badly to any suggestion that they may go away.

For a while, that didn’t do any harm. Inflation remained muted and rates as low as zero certainly encouraged growth. However, they created a problem.

If the monetary system that underpins capitalism is to work effectively, those who borrow must pay a price and those who lend must be rewarded. What we have seen since 2010 is a denial of that basic premise and a distortion of the market to such an extent that the very concept of a neutral rate that neither stimulates nor restricts has disappeared.

The current evidence suggests that maybe that the ideal rate is around 5%, a contention supported by the historical average. That, in turn, would indicate that cutting rates from here too quickly would be a much bigger mistake than leaving them at current levels for too long.

So, while a 5% base rate may seem to be seen by some as something to move away from as quickly as possible, historically, that really isn’t the case. Fundamental changes in economic conditions aren’t supposed to happen quickly. A period of stability that will gradually reduce inflation without causing a recession is possible at this point if the Fed has the courage not to cut rates this year.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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