Inflation data still pointing toward rate cuts in 2024

Inflation came in hotter than expected on Thursday, but we are still talking about rate cuts in 2024! The 10-year yield had a mild reaction to today’s data, increasing a few basis points early. It’s now at 3.98%, a far cry from 5.04% as we saw last year. This, while jobless claims data is still historically low.

As I have stressed time and time again, when the market believes the Federal Reserve is done hiking rates, the markets make a big move lower with the 10-year yield and mortgage rates. This has happened in every cycle for decades outside the late 1970s. We started to see this a few months ago when the 10-year fell from 5% to the recent lows of 3.80%. Now that we are talking about rate cuts, the 2-year yield, which is tied more to the Fed Funds rate than the 10-year yield, has dropped noticeably today.

From BLS: The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3 percent in December on a seasonally adjusted basis, after rising 0.1 percent in November, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 3.4 percent before seasonal adjustment.

Of course, the Fed mainly focuses on core inflation, and its primary inflation data is the PCE inflation report. However, we have made some good progress with the core inflation data in the CPI report in the past year.

Generally speaking, today’s headline and core inflation prints were hotter than anticipated. Rents are still lagging badly behind the current data, and even though the downtrend in shelter inflation is here, we are far from the reality. Used car prices were more firm than anticipated but also in the downtrend. As shown below, we have room to go lower in shelter.

Why the Fed will cut rates in 2024

It’s a simple premise for me: the Federal Reserve over-hiked because they panicked toward the end of 2022 going into 2023. The inflation growth rate was running hotter than they would have liked then, even though everyone knew that rent inflation was propping up the data at that point. They didn’t care — they still went hawkish in early 2023. However, they have room to cut in 2024 because the Fed Funds rate is much higher than the inflation growth rate if you look at it at on a 3 to 6-month timeline — and still higher versus 12-month data.

This means the Fed is still restrictive, and if they want a soft landing, they’re going to cut rates in 2024. If I was running the Fed, I would tell everyone we are getting the Fed Funds rate near where core PCE data growth is growing.This would mean, at minimum six to eight rate cuts this year, but that would give the market and the economy a way to get to neutral and not be old and slow.

All in all, the inflation data came in hotter than expected, but the market isn’t worried because the inflation data we have seen in the past two years came from a global pandemic and doesn’t have the same backdrop as the 1970s inflation. Like all inflation from a global pandemic, we will see some real hot inflation data up front and then the disinflation that occurs as supply chains get back to normal.