To Pause or Not to Pause?
That is the Fed Question. Hot economic data has furthered the idea that the Fed may be done with rate cuts (and has already paused) and that is the main reason we’re seeing stocks extend the year-end 2024 declines, as the less-dovish expectations push yields higher.
Given that, I want to look at the Fed from different angles and see if these fears of a pause are legitimate. What does the market expect? This has changed substantially. As of Friday’s close, fed fund futures have priced in just one rate cut for 2025 with that cut coming in June at the earliest. Additionally, there’s a 25%-ish chance of no cuts in 2025.
Bottom line, while concerns about a Fed pause have pressured stocks, market expectations have reset to a much-less-dovish place. So, while the Fed announcing a pause would still hit stocks, a lot of damage has likely already been done.
What does the economic data say? It’s important to remember that strong growth with falling inflation does still allow for another Fed rate cut. Here’s what’s important to remember: Strong data isn’t a problem. Strong data that the Fed thinks could boost inflation is a problem.
Right now, it’s not clear the strong data is the type that would boost inflation and that’s why it’s not getting major push back from the Fed. Bottom line, we need to focus on inflation, not just growth. Solid economic data won’t stop the Fed from easing unless that activity is so strong that the Fed thinks it’ll spike inflation. Right now, it’s not clear growth is strong enough to boost inflation, even though the numbers are stronger than estimates.
What does the Fed say? Fed speak was mixed last week and reflects a central bank that seems somewhat divided between continued rate cuts and a pause. The most important Fed speaker last week, Vice-Chair Waller, eased market fears by stating that he believed inflation was still trending towards the 2.0% target and even if it’s slowed, it’s still occurring. As such, he noted, additional rate cuts remain warranted. The FOMC minutes from December echoed those sentiments, with “many” on the FOMC expressing belief that inflation is still trending towards 2.0% (which keeps rate cuts on the table).
However, other regional officials were a bit hawkish. Fed Governor Bowman was explicit, saying she believed the December cut should be the last one for a while. Kansas City Fed official Schmid also said he believed Fed policy was close to neutral, which inherently means he’d be hesitant to cut further. Bottom line, Fed leadership matters and so far, Powell, Waller and Williams think inflation is still trending lower. As long as that’s the case, they’ll still be open to another rate cut.
Where does that leave us? Despite rising fears of a pause, neither the data nor Fed speak implies that the Fed is there yet. And with fed funds still far above annual inflation, Fed officials have room to continue to cut. The bottom line is that while the chances of a pause have risen, I don’t think the data warrants it at this point, and this market could be in for a bit of a relief rally if Fed leadership echoes that sentiment. What makes it worse? Any Fed-driven selloff will get substantially worse if we see the idea of rate hikes come back on the table. That is a worst-case scenario for stocks from a Fed standpoint and would be a bearish game-changer. If inflation reports are hot (including Wednesday’s CPI) we need to watch for rate hikes to re -enter the conversation because if they do, that’s a substantial negative. Don’t think that is going to happen!
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