Will the Federal Reserve cut rates this year?

THE positive outlook for interest rate cuts this year has vanished. At the start of 2024, the expectation was for six rate cuts, but now, this has shrunk to just one cut this year. Since the end of 2023, the iFast Research Team has maintained a contrarian stance of no rate cuts in 2024.

Fed delays cuts

US consumer prices accelerated more than anticipated in March. The consumer price index rose by 3.5 per cent year on year in March, up from an increase of 3.2 per cent in February. This marks the highest annual surge in the past six months.

This robust pace was primarily driven by increases in housing and petrol costs. Meanwhile, core inflation, which excludes volatile food and energy prices, stood at 3.8 per cent in March, significantly exceeding the Federal Reserve’s long-term target of 2 per cent.

The sustained increase in inflation cannot be dismissed as a temporary fluctuation. Fed chairman Jerome Powell noted that recent data has not instilled greater confidence, and suggested that it will take longer than expected to achieve the desired level of confidence in inflation trends.

Despite markets now anticipating only one rate cut this year, we still believe there will be none this year and expect interest rates to remain elevated for an extended period.

Robust US economy feeds inflation threat

Recent data indicates that the US economy is performing better than expected. Real GDP grew at an annual rate of 3.4 per cent in Q4 2023, surpassing earlier estimates of 3.2 per cent. Additionally, the economy added 303,000 jobs in March, with about 1.4 job openings for each unemployed worker. The Fed has also revised upwards its estimates of GDP growth (from 1.4 to 2.1 per cent) and core personal consumption expenditures or PCE (from 2.4 to 2.6 per cent).

Our view is that the US does not require rate cuts this year since the economy is performing well. Lowering rates when the economy is strong could risk triggering further inflationary pressures.

Middle East tensions and oil prices

Tensions in the Middle East have heightened since Iran conducted a retaliatory attack on Israel. This event has raised concerns, particularly regarding the involvement of Iran. Brent crude may increase in response, exacerbating inflationary pressures.

Two key risks have emerged. First is the risk of a wider conflict, as the Middle East accounts for about a third of global oil production. If other regional players take sides, the energy supply outlook could become more challenging.

Second is the risk of disruption to transit. The Strait of Hormuz handles almost 20 per cent of the global oil supply and a significant portion of shipping volumes. Iran’s proximity to this waterway raises the possibility of supply immobilisation.

The current precarious situation is influencing oil prices, which are expected to remain elevated. This is partly due to ongoing supply constraints, as Opec+ countries, including Saudi Arabia and Russia, have extended voluntary oil output cuts of 2.2 million barrels per day into the second quarter.

Looking further ahead, one can expect geopolitical tensions and conflicts to continue to affect oil prices. Events such as the Russia-Ukraine war, the Israel-Hamas conflict, the Red Sea attacks, the Ukrainian attacks on Russian energy facilities, and further escalations in the Middle East conflict have contributed to the current environment of sustained high oil prices.

Rates to stay higher for longer

Inflation and rates are likely to remain elevated for an extended period, particularly in light of persistent and elevated inflation in the US and heightened geopolitical tensions in the Middle East.

With this in mind, investors may consider the following investment strategies: Opt for short-duration bonds, and consider investing in quality companies and commodity-related stocks.

The writer is a research analyst with the research and portfolio management team of FSMOne.com, a Singapore subsidiary of iFast Corporation