Is Federal Reserve’s war on inflation really nearing its end?

Whispers in the financial corridors suggest the Federal Reserve might be close to declaring victory in its relentless battle against inflation. It’s like nearing the end of a marathon, legs are weary, but the finish line is in sight. The latest economic indicators hint at a phenomenon labeled “immaculate disinflation” – a scenario where inflation bows out gracefully without dragging the economy into a recession or jacking up unemployment.

With the U.S. economy flexing its muscles, growing at a robust annualized rate of 3.3% in the last quarter of 2023, one could argue that the Fed’s hawkish monetary policies are paying dividends. However, this growth translates to a less flashy 0.8% on a quarterly basis – a reality check for those who get dazzled by big numbers.

Parsing the Inflation Data

The Fed’s favorite inflation metric, the Personal Consumption Expenditures (PCE) deflator, is showing promising signs. The PCE, preferred over the Consumer Price Index (CPI), offers a broader and more consistent picture of household spending. For the number crunchers, the December figures are a sight for sore eyes. The core rate, which politely sidesteps food and energy prices, dipped below 3%.

Diving deeper, the annualized PCE inflation rates across various time horizons paint an intriguing picture. The 12-month figures, the usual yardstick for inflation, are just part of the story. More recent periods, when annualized, show inflation cooling to 2% or lower. Granted, some underlying measures, like the Dallas Fed trimmed mean and the Cleveland Fed median inflation measure, are stubbornly higher. But, let’s call a spade a spade – inflation seems to be tamed, at least for the last six months.

The Rate Cut Conundrum

The big question on everyone’s mind: what does this mean for interest rates? The recent inflation performance lines up nicely with the Fed’s projections. In December 2023, not a single soul at the FOMC expected lower inflation figures than what we’re seeing now. But before you break out the confetti, remember, December’s data doesn’t prophesize 2024. The Fed, like a cautious chess player, is likely to wait for more signs before signaling rate cuts.

If you’re betting on rate cuts, the odds are not in favor of a March reduction. CNBC’s Fed Survey reveals a more conservative outlook compared to the market’s exuberant expectations. Only 9% foresee a rate cut in March, with the majority expecting a downward move around June. Survey respondents are less bullish than futures markets, predicting just over three rate cuts this year.

Here’s where it gets interesting. The Fed’s decision is a balancing act. While there’s no pressing need to slam the brakes on the economy, they’re not in a hurry to ease off the pedal either. The reasons are fourfold: strong growth, uncertainty, fear of policy reversals, and the low cost of waiting.

The U.S. economy’s performance outstripped even the most optimistic forecasts from December 2023. This robust growth, coupled with the fog of uncertainty clouding the global landscape, makes a strong case for the Fed to maintain its current stance. Add to that the central bankers’ disdain for policy U-turns and the minimal pain felt in the economy, and you’ve got a recipe for patience.

Survey respondents see the Federal Reserve walking a tightrope. With a projected GDP slowdown to 1.3%, a slight uptick in unemployment to 4.3%, and CPI ending the year at 2.7%, the path ahead is fraught with both risks and opportunities.

In the grand scheme of things, the question isn’t if the Fed will reach its desired funds rate between 3.3% and 3.6% by 2025; it’s about how fast and carefully they’ll get there. Like a cautious navigator, the Fed is expected to steer clear of market expectations while leaning into a few rate cuts.