Economic and Interest Rate Update - March 2024

The economic and interest rate environments have been filled with uncertainty and volatility.  Since the beginning of last year, we have seen the Federal Reserve hike rates by 100 basis points to fight inflation; worked through 3 large unique bank failures; dealt with the collapse of a big crypto trading company; witnessed the continuation of Russia’s invasion of Ukraine; observed the increased conflicts in Israel and the Gaza Strip; and, managed through other notable risks.  It has been a difficult year, yet our economy continues to do well alongside inflation trending lower.  With the many ups and downs, what are the considerations going forward given the myriad of events?  Certainly, there are many, but the Fed’s restrictive monetary policy is arguably one of the main influences on our economy currently.  Understanding the Fed’s outlook on their areas of focus (inflation, the labor market, and the economy) may provide some insight on potential outcomes for 2024.

The Fed’s primary focus is inflation.  This has been reiterated time and again with the most recent at the Fed’s January 2024 meeting where their statement formally indicated, “The Committee is strongly committed to returning inflation to its 2 percent objective.” Jerome Powell, the Federal Open Market Committee Chairperson, was interviewed on 60 Minutes shortly after the Fed’s January meeting where he stressed, “[W]e’re very much committed to making sure that we fully restore price stability for the benefit of the public.”  The Fed was slow to start raising rates in the beginning, but their recent message at present aligns with their actions to fight inflation.  They have increased the Fed Funds rate by 100 basis points over the last year, and 525 basis points over the entire cycle which began in March 2022.  This has been the fastest and highest rate hiking cycle we have experienced outside of the 1970s and 1980s.  And, it has fortunately contributed to the decline in inflation.  The Fed’s preferred measure of inflation is the Core Personal Consumption Expenditure Index which been trending downward.  The latest reading at the time of this writing is 2.9%, which is close to their 2.0% target.  However, this measure is not close enough for the Fed.  Jerome Powell in the interview also commented that, “[The Federal Open Market Committee] wants to see more evidence that inflation is moving sustainably down to 2%.  We have some confidence in that. Our confidence is rising. We just want some more confidence…”

The Fed needs more confidence that inflation is moving sustainably lower, with an emphasis on the term, “sustainably”.  The Fed wants assurance that inflation will not reignite, which is exactly what happened in the 1970s and 1980s.  The Fed at that time moved the Fed Funds rate lower as inflation moved lower as well.  This was short-lived, though, as inflation spiked higher catching the Fed off guard.  It took an unprecedented rate hiking cycle from 4.75% to 20.00% to eventually tame inflation.  People suffered during this period, and this is exactly what the Fed is working to avoid at all costs.  Given this underlying concern, the Fed seems committed to their restrictive policy even if this negatively impacts the labor markets and the economy in the short run.

Despite the high rates, the labor market has been surprisingly resilient.  A popular measure for the labor market is the unemployment rate.  The latest reading was a strong 3.7% which is relatively close to historical lows of 3.4% which came in April 2023.  Unemployment rates across the different segments in our population are also relatively low, which indicates a broad-based strength in this measure.  This certainly is a positive, and surprising, to the Fed given this is one of their two mandates of managing to full employment in our economy.  Powell noted this sentiment in the interview, “[W]e thought that the pain would likely come, as it has in so many past cycles, in the form of higher unemployment. That hasn’t happened.  It really hasn’t happened. The economy has continued to grow strongly. Job creation has been high. Unemployment is still, you know, bouncing around near 50-year lows. The labor market is very, very strong still. So really the kind of pain that I was worried about and so many others were, we haven’t had that. And that’s a really good thing. And, you know, we want that to continue.”  But, will this continue? The areas of job growth have been targeted in part to the services sectors where travel-related businesses and restaurants have been hiring due to the strong demand from consumers in these areas.  This was especially evident in the recent readings for the economy.

The economy has continued to grow at a strong pace.  The most recent Gross Domestic Product readings was a surprising 4.9% and 3.3% for the 3rd and 4th quarters of 2023, respectively.  Consumer spending contributed the most to these readings.  As noted in the Bureau of Economic Analysis report, “consumers were spending on food services and accommodations as well as health care.”  This spending is coming from higher credit card usage.  While this is certainly not a good sign for the outlook of the consumer, it should also be noted that debt payments as percent of income is still within pre-pandemic levels.  So, the consumer may be borrowing more, but they are making more as well.  Hopefully, this is a healthy level for the consumer, but time will tell.

Given all of these factors, the Fed has indicated that they are still prioritizing the fight against inflation.  The labor market and the economy are strong which leads to the question of what the Fed’s next move is as it relates to their monetary policy of increasing or decreasing the Fed Funds rate. They have indicated that they are on hold until they have more data.  However, they have also forecasted that their current level of rates is expected to slow the economy to a soft landing and weaken the labor market.  For inflation, they want to be more assured that the decrease will sustainably continue.  The trend lower, though, has provided them with some comfort.  If this does continue, they have projected that they will lower rates at some point this year with the current forecast of cutting rates by 75 basis points in 2024.  These potential outcomes are to be taken with a grain of salt as with any future projections; however, these insights into the Fed’s thinking are helpful in that we can understand what is currently priced into the markets.  If the near-term data differs from these forecasts, we can be assured that readjustments in the markets and the Fed’s thinking will take place which supports the notion of continued economic and interest rate volatility in the near future.