Where did all the rate cuts go?

When this year began there were expectations of up to 6 interest rate cuts by the Federal Reserve in 2024. Now, we are looking at maybe 2, 1 or no interest rate cuts in 2024. How did we get here?

For starters, it is important to understand the dual mandates that the Federal Reserve is working towards. They are tasked with working toward both price stabilization (lowering inflation) and full employment. By increasing interest rates, they attempt to curb inflation. However, increasing rates too quickly or too much would potentially increase the unemployment rate. Even with the rapid interest rate increases in 2022 & 2023, the current rates are well within historic norms.

At their March meeting, the Federal Reserve left the possibility of three rate cuts on the table for the remainder of 2024, hinting they viewed strong inflation data earlier this year as a temporary bounce rather than a sustained resurgence. However, continued growth of inflation in March splashed cold water on this outlook, forcing markets to push out their expectations for rate cuts. As recently as April 16, Federal Reserve chair Jay Powell opined that it is likely to take “longer than expected” for inflation to return to the 2% target and justify rate cuts. The revival of the “higher for longer” narrative has put both stocks and bonds under pressure, while global central banks may have to reconsider their policy actions against a backdrop of a slower moving Fed. As investors wait for clarity on the path forward for policy, heightened geopolitical tensions and the upcoming U.S. election continue to cloud the outlook.  

                  U.S. Treasury Bond Futures

 The top graph above shows the performance of the S&P 500 from the end of 2020 through the end of the first quarter of 2024. The second graph tracks the performance of the U.S. Treasury Bond market over the same time period. On the S&P 500 graph, the arrows illustrate 3 distinct phases: the first was the recovery from the pandemic related crash in March 2020, phase 2 shows the sharp decline that can be attributed to fear surrounding inflation and the rapid-fire series of interest rate increases by the Fed, in the current 3rd phase it appears investors have accepted the Fed’s slower approach to fighting inflation and the idea that interest rates may stay at their current levels for some time. These 3 distinct phases all occurred against a backdrop of rapid increases in the Federal Funds rate. Of course we do not know if, or how much longer, the current trend in the equities market will be sustained.

 As seen in the second graph, fixed income values have dropped steadily during the Federal Reserve’s interest rate hikes (and current holding pattern). Sustained higher interest rates create a headwind for international stocks, as well as causing stress on bank balance sheets. We saw this recently with the failure of Republic Bank. Higher rates caused a significant decrease in the value of bonds in their reserves. While we do not believe that most banks face the same level of risk as Republic Bank, it does impact them.

 As always, we continue to monitor and assess the markets and economy. However, making assumptions or prognostications about what the Federal Reserve Board will do going forward are likely to be as accurate as they have been in the past. That is why, at AP Denver, we focus on working with our clients to create a financial plan and create a diversified portfolio that is designed to weather the unpredictability of the market. 

DISCLOSURES:  Securities offered through American Portfolios Financial Services, Inc., Member: FINRA, SIPC. Advisory services offered through American Portfolios Advisors, Inc. and Novem Group, Inc., SEC-Registered Investment Adviser firms. American Portfolios Denver, Inc. and Novem Group, Inc. are independent of each other and independent of American Portfolios Financial Services, Inc. and American Portfolios Advisors, Inc.