Written by Mohamed A. El-Erian
For the first time in a while, what the Fed is signaling about its interest rate settings this year is in line with what the market is expecting. More importantly, this was achieved without major disruption to the economy and markets. But underpinning it all are assumptions about policy behavior that are not fully supported by the Fed and not fully internalized by markets.
On the eve of this week's policy meeting, the market, which has continued to diverge sharply for an unusually long time, has increased the implicit number of Federal Reserve rate cuts in 2024 from the six to seven times expected at the end of last year. Adjusted from just 2 times to 3 times. This forecast is consistent with what the Fed has been warning about and will likely be verified by a dot plot released after Wednesday's meeting.
This alignment between markets and the Fed entailed higher market yields over the entire period, with surprisingly little damage to stocks or the economy. Major US stock indexes remain near all-time highs. The economy remains strong overall, although some weakness can be seen in some areas. It is faring much better than most other advanced economies, and fewer than a year ago expect it to slip into recession any time soon.
All of this makes sense if accompanied by a nuanced understanding of what the Fed intends to do going forward (and, in my opinion, what it should do for the health of the overall economy). I am.
It has become increasingly clear in recent weeks that the Fed faces challenges in the “last mile” of reaching its 2% inflation target. The first phase of this effort saw headline CPI inflation, the most widely followed measure by the general population, fall from more than 9% in June 2022 to just over 3% in recent months. This was due not only to the slowdown in price growth, but also to the complete decline in goods, which overwhelmed the robustness of services. In addition, the decline in core CPI inflation has been slower, with energy deflation playing an important role.
