New reports indicate that inflation meaningfully declined last month, a development that investors are interpreting to mean that the Federal Reserve is likely done with raising interest rates and may start cutting them before long.
The consumer price index, updated Tuesday, showed that inflation dropped half a percentage point to 3.2% for the year ending in October. On a month-to-month basis, price growth was flat at 0%, better than expectations and a sign that the Fed’s at-times-aggressive rating-hiking cycle has been working.
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A separate report on Wednesday about the producer price index showed wholesale inflation inflation declining to just 1.3% for the year ending in October. Wholesale prices fell a half percentage point in just October alone, the biggest drop since April 2020, when the pandemic was throttling economywide demand.
That two reports are buoying optimism that the Fed’s interest rate target of 5.25% to 5.50% is its terminal rate and that the next rate revision — whenever that will be — will be a cut to the rate target.
“I believe we’ve already reached the peak in terms of interest rates,” said National Association of Realtors chief economist Lawrence Yun. “The question is when are rates going to come down?”
Indeed, investors are already pricing in the notion that the central bank is done with its tightening cycle.
The next meeting of top Fed officials is slated for mid-December, and after this week’s two inflation reports, investors now see a 99.9% probability that the Fed will not hike rates at this coming meeting, according to the CME Group’s FedWatch tool, which calculates the probability using futures contract prices for rates in the short-term market targeted by the Fed.
The overwhelming majority expect the Fed’s rate target to remain at 5.25% to 5.50% through March of next year, and they assign about a 25% probability that rates will be cut by then. Things become less certain following the Fed’s May meeting, where they are pricing in a nearly 60% chance there will be at least one rate cut by then and 41% odds that rates will be where they are now.
By the end of next year, investors are implying greater than 50% odds that interest rates will be a full percentage point (or more) lower than they are now — which means there will be at least four rate cuts in 2024.
“These data support recent Fed decisions to hold policy rates steady,” said Rubeela Farooqi, chief United States economist at High Frequency Economics, after the wholesale inflation report. “Our baseline remains that rates are at a peak. For the Fed, geopolitical developments will be an additional risk factor that will keep policymakers proceeding cautiously with rate hikes going forward … but there is nothing in today’s figures to prompt any thinking at all about more policy interest rate increases.”
Notably, Fed chairman Jerome Powell has not yet closed the door on the possibility of raising rates, should inflation prove to be stickier than expected.
In remarks to the International Monetary Fund, a speech which was briefly interrupted by climate protesters, Powell emphasized that it is still unclear whether interest rates are sufficiently high to tamp inflation down to the central bank’s 2% goal.
The Fed “is committed to achieving a stance of monetary policy that is sufficiently restrictive to bring inflation down to 2% over time; We are not confident that we have achieved such a stance,” he said.
“If it becomes appropriate to tighten policy further, we will not hesitate to do so,” Powell added. “We will continue to move carefully, however, allowing us to address both the risk of being misled by a few good months of data, and the risk of overtightening.”
Economists and the Fed are also closely watching the labor market. When rates go up, it can cause the broader economy to soften — the idea is that the decline in demand causes excess supply and allows prices to move lower. That process can cause employers to lay off workers.
This year, despite the rate increases, the labor market has remained unexpectedly strong.
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The economy has added more than 200,000 jobs a month over the past three months, a strong pace by historical standards.
Gross domestic product growth — a relative measure of the country’s overall economy — has also remained robust. GDP growth ended up increasing to a red-hot 4.9% seasonally adjusted annual rate in the third quarter of this year, up from a still-strong 2.1% the quarter before.