The Decembrist revolt

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Turns out that last December’s inflation-control victory lap was a little premature.

After a stronger-than-expected CPI print on Wednesday, Bank of America and Deutsche Bank are both now predicting that the Federal Reserve won’t cut US rates until this December. Both had previously expected June (DB says “June or July”).

That’s even with some quirks in the inflation data that smart folks online have been pointing out.

First, much of the persistent inflation strength has come in shelter costs, and there was a bit of a dust-up over the calculation of owners’ equivalent rent (involving a mass email to economic-data “super users”).

Second, auto-insurance prices — our favourite CPI component from the past year! — has also been more muted in the PCE, the Fed’s preferred inflation gauge.

Still, while the Fed likes to use PCE, most people experience CPI (ie they don’t wreck their cars). As BofA puts it:

Much of the firmness in March came from motor vehicle insurance, which rose 2.6% on the month and 22% y/y, and medical care services, which rose 0.6% on the month. These components may not feed directly into PCE inflation, but they send a signal of inflation firmness that we think will give the Fed less confidence to cut. Put differently, and in the words of Fed Governor Waller, “what’s the hurry?

And 2-year Treasuries have sold off quite a lot this week:

All of this helps explain why the banks are pushing back their rate-cut calls. From BofA:

We now expect the Fed to start cutting rates in December. We no longer think policymakers will gain the confidence they need to start cutting in June.

2024 is starting to look like 2015, but in reverse. Then the Fed signaled hikes it could not deliver; now the Fed may be signaling cuts that the inflation data do not justify. We continue to expect the Fed to cut four times (or by 100bp) in 2025 and two times (50bp in 2026).

There are some interesting implications here. How much economic cooling would be required to deserve 100 basis points of rate hikes in 2025? The strategists don’t address this explicitly. Instead they argue that four 2025 cuts will be considered a slow-and-steady pace, and that central bankers will aim to deliver cuts when they can also deliver economic projections to add a bit more messaging to the decision.

Deutsche Bank, in contrast, has even more muted expectations for rate cuts after this year. The bank’s economists expect just two “insurance” cuts in 2025, and a few more the following year:

Accounting for these developments, we have materially adjusted our Fed view for this year. We now expect only one rate cut this year at the December FOMC meeting followed by modest further reductions in 2025. Beyond next year, we expect the Fed to guide the policy rate back towards a neutral level that is likely just below 4% by the end of 2026. A reduction in July is possible, though it likely requires a string of more favorable inflation prints than we currently forecast.

Futures markets are getting in line with the sellside view for 2024. The CME’s Fed watcher is predicting a roughly one-in-three probability that the Fed’s first 25bp cut will come in December, and a comparable likelihood that its second 25bp cut will arrive that month. (To simplify a bit: Fed funds futures markets imply one to two rate cuts this year, or possibly one 50bp cut.)

Notably, both Deutsche and Bank of America say that the Fed will stop cutting rates earlier than it had previously estimated, implying that something structural changed in the US economy that makes it able to withstand higher interest rates.

It’s not clear yet whether this means the R-star empire is striking back. Do leave other corny jokes about December/R-star/our excellent merch in the comments.