High Interest Rates and Impending Fed Rate Cuts: How to Navigate 2024 

From the exuberant recovery of the 2020s following the pandemic, to the looming threat of recession, and now navigating the landscape of US exceptionalism, Goldilocks scenarios, and the prospect of a soft landing, market participants are ensnared in a whirlwind of narratives that shape market sentiment. 

In this ever-changing environment, markets thrive on themes that resonate with buyers and sellers, guiding their decisions on when to enter or exit positions. These narratives can stem from fundamental economic factors, technical analysis, geopolitical tensions, or sudden shocks that fluctuate in significance over time. Some themes endure for extended periods, while others may swiftly dissipate. 

Currently, traders are closely monitoring the anticipated timing of interest rate cuts by central banks. This key factor is expected to influence the prices of all asset classes, including the value of the dollar, stock markets, and gold. 

This fixation on interest rates underscores the pivotal role that central banks play in shaping economic conditions, making it a focal point for traders as they navigate the complexities of the financial markets. 

Key Points 

• Traders are closely watching the timing of interest rate cuts by central banks, with such decisions expected to significantly impact various asset classes, including stocks, the dollar, and gold. 
• Despite previous expectations of a recession, the US economy has shown resilience, supported by consumer activity and investments driven by the Inflation Reduction Act, leading to a more cautious approach towards interest rate cuts in 2024. 
• The Federal Reserve is balancing the need to control inflation without prematurely signalling rate cuts that could reignite inflation pressures, with the upcoming US election adding complexity to the timing of potential policy adjustments. 

A look at Current Interest Rates and Why They’re so High 

Sharp increases in interest rates have become a necessary response by central banks to counteract inflationary pressures, which soared to multi-decade highs not long ago. More recently, there has been a cooling of hot consumer and producer prices due to various factors, including the gradual healing of supply chains after the pandemic. However, the Consumer Price Index (CPI) still remains elevated, exceeding the 2% medium-term target set by most major central banks. 

US exceptionalism has emerged as a significant narrative in the markets, as the economic resilience of the world’s largest economy continues to defy expectations. Despite widespread predictions of a recession in 2023, the American economy has persisted far longer than anticipated. S&P Global Ratings recently revised its US forecast significantly upward, citing a larger-than-expected expansion at the end of the previous year and a more robust labor market compared to previous assessments. The rating agency now anticipates real US GDP growth of 2.4% for the current year, up from its previous forecast of 1.5%. 

Despite expectations, the most aggressive series of rate hikes in a generation has not had an immediate impact on the economy. The dire condition of other major economies has added to the prevailing pessimism. High interest rates are typically intended to curb borrowing, leading to reduced business and consumer activity. Last year, a regional banking crisis in the US and ongoing conflicts in Ukraine and the Middle East further fuelled concerns of a global economic downturn. 

However, the Federal Reserve has navigated a path away from the feared hard landing scenarios. Consumer activity has remained resilient, fuelled in part by the surplus savings accumulated during the pandemic. The Biden Administration’s Inflation Reduction Act has proven unexpectedly effective in driving investment, while a resurgence in the housing market, despite historically high mortgage rates, has also bolstered construction activity. 

Impact of High Interest Rates 

High interest rates work to reduce inflation by dampening demand in the economy, making it more attractive to save and less attractive to borrow. This is meant to quell activity by reining in investment and causing the economy to slow down.  

The anticipation of rising and high interest rates have been a key long-term market theme for over a year. However, 2024 was expected to mark a shift towards rate cuts, with expectations of easing monetary policy beginning within a few months following the historic tightening seen in previous years. 

Nevertheless, the narrative has evolved, with expectations of substantial policy easing being delayed until mid-year from early spring. Consequently, the total number of anticipated rate cuts has nearly halved, from seven in January to around four 25 basis point reductions currently. 

This adjustment signals a change in the dynamic between the Federal Reserve and the market, which have been engaged in a back-and-forth exchange of outlooks on interest rates for several months. However, a series of robust economic reports has bolstered the Fed’s position and led the market to align more closely with the FOMC’s patient stance towards policy easing. 

Fed Rate Cuts in 2024 

At their December FOMC meeting, policymakers projected an average of three rate cuts for 2024 as slowing price growth raised hopes that inflation had been subdued. Currently, rates stand at a more than two-decade high, ranging from 5.25% to 5.50% ^[1]. The recent minutes of that meeting reaffirmed officials’ caution about cutting rates too swiftly, emphasising their “highly attentive” stance toward inflation risks. 

Traders, wary of past instances where Fed forecasts missed the mark, had anticipated that a sharp slowdown in inflation would prompt the central bank to act more swiftly. However, recent data releases have prompted the Fed to push back against these expectations. 

Ultimately, rate cuts will occur when policymakers are convinced that interest rates are restrictive enough to guide inflation decisively back to the 2% target ^[2]. This entails a decline in core inflation, which excludes volatile food and energy components, from its current level of 3.9% ^[3]. 

How Should Traders Navigate 2024? 

A significant concern for the Fed is avoiding signalling a historic pivot toward initiating a cycle of rate cuts, which could potentially reignite inflationary pressures. Indications of the central bank’s readiness to ease could elevate consumer inflation expectations, prompting companies to raise prices in response. 

The labour market remains robust, particularly at this stage of the economic cycle. Unemployment rates are low, jobless claims are minimal, and the US continues to add jobs. This dynamic becomes the primary risk event if inflationary pressures begin to abate. 

Ultimately, wages need to decline to mitigate persistent services inflation, which remains stubbornly high. This could lead to a weakening of the dollar as the US economy softens and the Fed embarks on a series of rate cuts. Stocks may experience a pause or be subject to profit-taking, especially in certain sectors that have seen significant gains, while gold could benefit as bond yields decline. 

Conversely, the prospect of a “no landing” scenario, where inflation resurfaces, bringing rate hike considerations back into play, has gained traction recently. Indeed, navigating this landscape presents challenges for both the Fed and traders, although rate cuts remain the more probable outcome as elevated borrowing costs eventually filter through. 

Investors must also factor in the November US election, which adds another layer of complexity to the latter half of 2024. If the Fed were to pursue rate cuts, one argument suggests they might opt to implement them early to avoid any perception of political bias around election time. Dive deep into our analysis as we discuss the market outlook for 2024, and understand how these economic dynamics could influence the financial markets.

References

1. “Federal Reserve expected to keep interest rates at more than two-decade high – Yahoo! Finance”. https://finance.yahoo.com/news/federal-expected-keep-interest-rates-092646490.html. Accessed 27 Feb 2024.
2. “When will the Fed cut interest rates in 2024? Here’s what experts now say and the impact on your money. – CBS News”. https://www.cbsnews.com/news/interest-rate-cut-2024-when-will-fed-cut-rates-inflation-experts/. Accessed 27 Feb 2024.
3. “Inflation ticked up to 3.4% in December thanks in part to outsized housing costs – CNBC News”. https://www.nbcnews.com/business/economy/inflation-rate-december-2023-falling-prices-impacting-consumers-rcna133050. Accessed 27 Feb 2024.