The US Federal Reserve and its vast global audience thought 2024 would be a rate-cut bonanza. But with inflation proving stickier than almost anyone predicted, those expectations are fading fast. Fed Chair Jerome Powell confirmed as much on June 12, when he and his fellow policymakers signaled there would be just one cut in 2024 and forecast more for 2025, reinforcing policymakers’ calls to keep borrowing costs higher for longer to suppress inflation.
Traders now see just one or two rate cuts happening this year. That’s a big letdown from the roughly six they expected at the start of the year and the three that Fed officials penciled in as recently as March. Some investors and economists say there’s a chance of no cuts at all this year.
The delay in easing monetary policy — and keeping rates “higher for longer” — has big implications for the US economy. It’s also reverberating around the world.
1. What’s keeping inflation elevated?
When inflation peaked above 7% in 2022, it reflected a broad-based increase in the price of goods and services. But now, with a key inflation measure back below 3%, price increases are being driven mainly by a persistent shortage of housing. Commodity prices and car insurance premiums are also contributing to the stickiness keeping inflation above the Fed’s 2% target.
Some also point to Powell himself for prematurely telegraphing interest-rate cuts, which ignited optimism in financial markets and fueled economic activity. Here’s a closer look at each of those factors:
• Shelter, which accounts for about a third of the consumer price index, has proved the most stubborn category. Despite some timelier measures from the Bureau of Labor Statistics, Zillow Group Inc. and Apartment List that show rent growth for new leases coming down, the corresponding components in the CPI have yet to reflect that.
• Energy prices — specifically oil — climbed in the first quarter after falling for much of last year. Any escalation in the war in the Middle East threatens to push them even higher. The rally has translated to more expensive gasoline. Electricity prices have also climbed. Although central bankers prefer to look at so-called core measures of inflation that strip out energy prices because of their volatility, the surge in the price of oil and other raw materials has proved impossible to ignore, because it can manifest in costlier shipping and merchandise.
• Insurance costs are another driver of high inflation. Tenants’ and homeowners’ insurance is rising near the fastest rate in nine years, while auto insurance skyrocketed 20.3% in the year through May. A key reason: Cars are more technologically complicated now and therefore cost more to repair.
• Powell spurred big market bets on rate cuts by saying in December that cuts were “clearly” a topic of discussion at the Fed. The comments’ effect was equal to lowering interest rates by 0.14 percentage point — and also will add about a half percentage point to the CPI this year, according to Anna Wong, chief US economist at Bloomberg Economics.
2. What are the domestic implications of “higher for longer” rates?
The Fed’s benchmark rate affects borrowing costs across the rate spectrum. Powell’s signaling that the Fed might hold the rate at the current level of 5.25% to 5.5% for longer means that loans for home and car purchases will continue to be much more expensive than they were before the Fed started raising rates in 2022.
Indeed, average mortgage rates in the US have stayed above 7% for the past two months. The cost of financing has hindered recent momentum in the housing market as prospective buyers move to the sidelines until financing costs ease. Also, inventory remains low because so many homeowners don’t want to give up the cheap mortgages they got when benchmark rates were near zero. That’s helping to keep listing prices high.
3. How does Fed policy affect the rest of the world?
Despite the Fed’s stance to stay on hold, some of its global peers are moving forward with rate cuts anyway. Last week, the Bank of Canada led the Group of Seven in lowering borrowing costs, and the European Central Bank followed suit. If those institutions, along with the Bank of England and Reserve Bank of Australia move ahead with their own easing cycles, that risks driving down their currencies — raising import prices and undermining progress in getting inflation down. But not easing could risk lost growth.
The ECB, for its part, all but ruled out a second interest-rate cut in July, and some also question if such a move would be wise at the following meeting in September. The BOE pivot to rate cuts is likely to take longer, with traders pricing the first reduction in the fall. Bank of Canada Governor Tiff Macklem made it clear that Canada’s interest rate policy doesn’t need to move in lockstep with that of its southern neighbor, despite the potential for downward pressure on the loonie.
Higher for longer keeps the dollar strong against other currencies, because the prospect of persistently lofty US rates makes investment in US securities more appealing on a relative-value basis, causing the greenback to appreciate. So with every tick higher in the dollar, things gets tougher for developing economies — especially for those that have dollar-denominated debt that becomes more expensive to pay back as their home currency weakens.
Bank Indonesia had to raise rates in October and again in April after an extended bout of currency weakness. The central bank had to intervene in currency markets as the rupiah weakening beyond 16,000 for the first time in four years. For countries from Malaysia to Vietnam, economists now expect fewer rate cuts.
This article was provided by Bloomberg News.