Markets Are Excited About Rate Cuts. They Might Be Disappointed

With economic conditions still strong, many investors, including in CRE, are looking forward to falling interest rates and more favorable conditions in 2024.

After all, the Federal Reserve has indicated a good chance of three quarter-point drops by year’s end. But markets have taken a bit of good news and stretched it out beyond what might be realistic. That could be bad news in the end.

Christopher Walker, a Fed governor, noted in a speech this week before the Brookings Institution, that economic news has been good.

“But will it last?” Walker asked. “Time will tell whether inflation can be sustained on its recent path and allow us to conclude that we have achieved the FOMC’s price-stability goal. Time will tell if this can happen while the labor market still performs above expectations. The data we have received the last few months is allowing the Committee to consider cutting the policy rate in 2024. However, concerns about the sustainability of these data trends requires changes in the path of policy to be carefully calibrated and not rushed.

According to the January economic report from John Beuerlein, chief economist at the Pohlad Companies, parent of Northmarq, “Markets are pricing in five cuts in interest rates beginning in March or May, however there was nothing in the minutes of the Fed’s [December] meeting to suggest that the Fed is close to starting to cut rates, or that it plans to cut rates as much as markets are currently expecting.”

Beuerlein points out that the inflation-adjusted federal funds rate is at its “most restrictive level since 2007” at 2.7%. If the Fed’s economic projections turn out to be accurate, the real rate will be 2.2%.

“In short, while interest rates may have peaked, the Fed appears willing to keep rates elevated until they see a more substantial slowdown in the economy and sustained easing of inflationary pressures,” Beuerlein wrote.

Athanasios Vamvakidis, a U.K.-based forex strategist at Bank of America, goes further, suggesting value in considering the “extreme scenario” that central banks don’t cut rates,MarketWatch reported. He sees markets having priced in not five but six rate cuts across the Fed and European Central Bank, with the Bank of England doing five cuts and the Reserve Bank of Australia cutting twice.

“The most important discussion in the market as the new year has started is not if, but when and how fast G-10 central banks will start to cut policy rates,” Vamvakidis said. “Even if a scenario of central banks staying on hold this year may seem completely unrealistic to the consensus, it is still worth considering its market implications in our view, as we are puzzled by the aggressive market pricing of rate cuts this year.”

Source: GlobeSt