Markets have frequently underestimated Federal Reserve (Fed) actions over the last few years, but lately the skepticism has been striking.
Fed fund futures traders are increasingly betting on a rate cut, even as data show an economic rebound could be in progress. As shown in the LPL Chart of the Day, fed fund futures are pricing in a 40% chance of one rate cut and a 20% chance of two rate cuts before the end of 2019.
Some nervousness around Fed policy is understandable. The Fed paused rate hikes in January amid global uncertainty, and consumer inflation has weakened over the past few months. Core personal consumption expenditures, the Fed’s preferred inflation gauge, rose 1.6% year over year in March, its slowest pace of growth in 18 months. While that pace isn’t alarmingly slow, the downward trend runs counter to the Fed’s intentions.
However, it’s tough to see a Fed rate cut in the near future with over 3% economic growth in the last quarter, healthy wage growth, and a labor market nearing full employment. The Fed has reduced its benchmark rate only 45 times since 1950, with the last rate cut happening in December 2008. Only 12 rate cuts occurred after a quarter with output growth of 3% or more. In many of those instances, leading indicators had signaled impending weakness.
“We see plenty of evidence that solid U.S. fundamentals are intact even as the global economy struggles with trade and political risks,” said LPL Research Chief Investment Strategist John Lynch. “We expect U.S. growth to stabilize and inflation to creep higher as these risks subside, which could eventually lead to more Fed tightening.”
This week, we’ll likely get more details on the Fed’s view of future policy when the Fed concludes its latest policy meeting onMay 1. Fed fund futures are overwhelmingly predicting unchanged rates for this meeting, consistent with the Fed’s messaging of a pause in rate hikes. We won’t see an update to official economic and rate projections at this meeting, but the Fed could provide helpful context on economic conditions and inflation.
For more of our thoughts on the U.S. economy, check out our latest Weekly Economic Commentary: First Quarter’s GDP Surprise.
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