Fed Faces ‘Soft Deadline’ for Rate Cuts as Inflation Progress Stalls

The bump in the Federal Reserve’s path to lower inflation is looking more like a roadblock, throwing into doubt its plans for interest rate cuts this year.

The figures out yesterday mark the third straight month in which a key gauge of U.S. inflation exceeded economists’ expectations. Consumer prices excluding food and energy climbed 0.4 percent from February and 3.8 percent from a year earlier, the same as the month prior.

Investors now see a chance of fewer than two interest rate cuts this year, futures show. And while a narrow majority of Fed officials penciled in three or more reductions for in 2024, the stalling in inflation progress runs the risk of not only delaying future cuts but also limiting the Fed’s ability to cut at all.

“This marks the third consecutive strong reading and means that the stalled disinflationary narrative can no longer be called a blip,” said Seema Shah, chief global strategist at Principal Asset Management. “In fact, even if inflation were to cool next month to a more comfortable reading, there is likely sufficient caution within the Fed now to mean that a July cut may also be a stretch, by which point the U.S. election will begin to intrude with Fed decision-making,” she said.

Some economists had started to opine that if the Fed doesn’t cut by June or July, reductions will likely need to be pushed out to 2025. That’s because annual inflation is set to make little progress in the second half of the year, as the figures are compared with a period in late 2023 when price pressures were rapidly easing.

“It is somewhat of a soft deadline, and it would really complicate the picture for rate cuts,” said Matthew Luzzetti, chief U.S. economist at Deutsche Bank. With inflation sticky and the economy resilient, “those conditions have combined for reducing the prospects of rate cuts this year.”

Fed Chair Jerome Powell and other policymakers have said they don’t want to start cutting rates until they have sufficient confidence that U.S. inflation is headed to the central bank’s 2 percent target on a sustainable basis.

Officials have also pointed to the strength of the economy and labor market, which added more than 300,000 jobs in March, as reasons the Fed can afford to be patient with reductions. Powell said last month that the Fed wants to see “more good data” on inflation but has been vague on details.

The first three months of the year have been marked by worse-than-expected price reports. The Fed’s preferred gauge of underlying inflation, of which the March reading will be released later this month, was up 2.8 percent in February from a year earlier. The Federal Open Market Committee (FOMC) anticipates that gauge will fall to 2.6 percent by year end, according to policymakers’ latest quarterly projections.

“Essentially, whatever the year-on-year inflation is by June is likely to be around that level at the end of the year,” said Michael Gapen, head of U.S. economics at Bank of America Corp.

“The jump risk would be, if you don’t move in June,” he said, the first cut “could move from June to next March.” Policymakers have held interest rates at a more-than-two-decade high since July.

The Political Picture

While Fed officials have stressed that the central bank makes decisions without regard to the political impact, cutting for the first time in September would invite heightened scrutiny ahead of the presidential election in November.

“One of Chair Powell’s responsibilities is to protect the public standing of the Fed,” said Vincent Reinhart, chief economist at Dreyfus and Mellon and a former top Fed staffer. “The closer the FOMC acts to the election, the more likely it is that the public will question the Fed’s intent, undermining its democratic legitimacy.”

The risk of such blowback was apparent yesterday, when former President Donald Trump lashed out at the Fed following the inflation report. “INFLATION is BACK—and RAGING!” he said on his Truth Social platform. “The Fed will never be able to credibly lower interest rates, because they want to protect the worst President in the history of the Untied [sic] States!”

Some economists don’t see the election holding back the Fed. Rather than annual inflation numbers, Powell and his colleagues could cite three-month and six-month averages of inflation to gain confidence that inflation is heading to its 2 percent target, said Diane Swonk, chief economist at KPMG LLP. She still expects the central bank to cut rates in the second half of the year, but acknowledged the March data was bad news for the Fed.

“One cut is quickly becoming the norm” for 2024, she said.