FED Chairman Powell again downplayed the possibility of rate cuts before the end of the year.

FED Chairman Powell again downplayed the possibility of rate cuts before the end of the year. Could further rate hikes really happen, and is the idea of a rate cut or cuts by year-end a fairy-tale? Or is this all just a front by the Fed? We suspect that it may be a case of the latter.

When we say this could all be a front by the Fed, what do we mean? What we mean is that the Fed is almost duty-bound to say that rates could rise again but, in reality it would probably take a significant change in the trend of economic data to force the Bank to act. The Fed is presumably not expecting such a change.

In other words, it will be assuming that the pace of payroll growth will continue to fall, and that price pressure will continue to recede as well. Quite clearly, it is taking a chance here and that lends itself to keeping open the optionality to lift rates again. Should data, starting with today’s labour market numbers, come through significantly stronger than expectations the Fed could be quickly tested by the market.

However, Fed is minded to stop rate hikes and it would take something pretty dramatic to make it change its mind. Part of the Fed’s expected resolve is down to the fact that rates are now at the peak level that FOMC members have been suggesting for some time. Part is down to how economic data has been developing and another part may also be due to the risks to the economy arising from the banking strains that we are seeing in regional banks.

Is it still possible that developments in the economy could pressurise the Fed into another rate hike, or hikes? This seems unlikely. For a start, the market is now pricing in close to 75-bps of rate cuts by the Fed by the end of the year and as long as these expectations do not change significantly it seems unlikely that the market will press for a near-term hike before the cuts can start at a later date.

This brings us on to the second question. Is Powell’s refusal to entertain the idea of rate cuts later this year a true sign of the Fed’s reticence, or is it a front as well? Here too, it could be a case of the latter simply because the Fed knows that opening up any possibility of rate cuts too soon could undermine the work that has been done in tightening financial conditions.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said in the worst-case scenario, the Fed could be forced to hike rates again now in order to prevent financial conditions easing too far because the Fed itself encouraged the possibility of rate cuts later this year. If this is a front by the Fed then it suggests that the idea of rate cuts this year is indeed in the mind of Fed policymakers, even if they are not willing to admit it right now. Traders and investors are well aware that they have history on their side because the length of time between the last Fed rate hike in the cycle and the first cut is often not much more than six months. But much of this history covers the low-inflation period and the issue is whether things are different this time because inflation has risen so much more.

On this we have mixed feelings. Yes, we do think that things are different given such high inflation, and the fact that the source of this inflation (constraints on supply rather than excessive demand) is different to before. This could quite easily make the Fed hold the rate peak well into next year, perhaps even longer. But on the other side, financial markets are still likely to see the current situation as more akin to prior experience and hence will continue to believe that the gap between the last hike and first cut could be little more than six months.

“Right now, our call is that the Fed will start to cut in the early part of 2024 but we’ve no doubt that if this is wrong it will more likely be because the Fed starts the easing cycle earlier, not later”, said Mr. Steve Barrow.