The Fed probably won’t raise rates

Good morning. It’s Kate Duguid in New York; thanks for having me back to guest host Unhedged while Rob is off. It’s never a good idea to be the follow-up act to Katie Martin, but here goes.

First, though, Nvidia. The chipmaker’s shares had dipped ahead of yesterday’s earnings, perhaps on the thought that beating investors’ sky-high expectations would be too hard. But no! Nvidia blew estimates out of the water. Its stock was up 9 per cent in after-market trading. If you were looking for a downside, our smart stocks correspondent Nick Megaw notes that sales in China continue to pose a challenge as export rules have forced the company to scale back in the region. But for now it doesn’t seem to be enough to offset blowout numbers everywhere else. 

Songs of praise can be sent to kate.duguid@ft.com. All complaints to ethan.wu@ft.com. 

The Fed probably won’t raise rates again

Is it bananas to say that the Federal Reserve could raise interest rates this cycle? Put another way, am I willing to call Larry Summers bananas? 

In an interview with Bloomberg last week, the economist said that because of persistent inflationary pressures, there was a “meaningful” chance — he put the odds at around 15 per cent — that the Fed’s next move on rates could be an increase. “The worst thing you can do when the doctor prescribes you antibiotics is finish part of the course, feel better and give up on the antibiotics,” said Summers. 

It’s not just Summers, either. Bloomberg followed up the interview with a big piece titled “Markets Start to Speculate If the Next Fed Move Is Up, Not Down”. Mark Nash, who manages the absolute return macro fund at Jupiter Asset Management, told Bloomberg that he put the odds at 20 per cent. 

(A note on 15 per cent odds — that’s the same chance an NFL kicker has of missing a 37-yard field goal, but also the odds that The New York Times put on Donald Trump winning the 2016 election.)

Summers’ argument comes just after a big market rethink of where rates are going. At the start of January, the futures market had six quarter-point cuts priced in. These market expectations were always at odds with the Fed’s own forecasts, but traders were betting on a rapid deceleration in inflation this year — like we saw in the back half of 2023. Since January, the macro picture has changed a bit. Inflation is falling slower than expected and the jobs market looks sturdy. That is on top of clear signals from Fed chair Jay Powell that the Fed would take its time before cutting. So rates traders reined in their expectations. Today, three to four cuts are priced in, starting in June rather than March:

Market expectations are now much more in line with the Fed’s own thinking. The central bank’s December projections showed the average official forecasting three cuts in 2024, a view that Powell restated at the bank’s January meeting, and then again in a February interview on CBS’s 60 Minutes. 

Combining the somewhat more inflationary economic picture with the trend in market expectations for rates, does it make sense to start betting on the chance of a rise? I don’t think so. 

Start with Summers’ argument. He mostly cited January CPI figures, which did come in hot. Headline inflation cooled less than expected, leaving the year-over-year rate at 3.1 per cent. Core inflation was stagnant at 3.9 per cent. Summers focused especially on “supercore” (non-shelter services) and on owners’ equivalent rent, which rose an annualised 7 per cent in January. 

Though he conceded it was just one month of data, Summers said the CPI numbers could also mark a “mini paradigm shift”. But that seems far-fetched, or at least too early to tell. The day it happened, Ethan laid out why we should take the data with a grain of salt: inflation expectations look calm, the OER jump looks like noise, and January inflation data tends to be wonky. It is reasonable to think that February’s figures will be a little cooler. 

Yes, stock and bond markets did take the inflation data poorly. But that speaks less to the data itself than the amount of disinflation and rate-cut optimism priced into markets. The below chart from Meghan Swiber, US rates strategist at Bank of America, shows just how out of whack the market was with Fed expectations. The market-Fed expectations disconnect has only been so wide in previous moments of crisis (March 2020, the Silicon Valley Bank mini-crisis) or during monetary policy pivots: 

There is no sign from the Fed that it expects to raise interest rates this year. The minutes from January’s Fed meeting, released on Wednesday, showed officials were “highly attentive” to inflation risks and wary of cutting interest rates too quickly. Buoyant stock and credit markets are adding to Fed caution: “several participants mentioned the risk that financial conditions were or could become less restrictive than appropriate, which could add undue momentum to aggregate demand and cause progress on inflation to stall.” But in spite of all these reservations, the Fed is still only talking about rate cuts. 

“The odds of an outright hike are tough, because the Fed would have to see a significant reacceleration in core inflation momentum, ” said Gennadiy Goldberg, head of US rates strategy at TD Securities. It’s important to note that the Fed can only influence certain types of inflation. Any reacceleration would likely have to occur in core inflation — ie, not including higher energy prices — and would have to reflect overly strong demand. Supply chain snarls might not count.

And even in the case of re-accelerating core inflation, the Fed still might not raise rates. 

Markets are sufficiently all-in on cuts this year that failing to deliver them would be “toxic”, said Goldberg. You could get a dramatic repricing: tanking equity markets, widening corporate credit spreads, much tighter financial conditions. This would do much of the Fed’s work for it. “Just by keeping rates at [today’s] 5.5 per cent, the Fed would be doing a fair amount of tightening,” said Goldberg. This is the strongest point against increases: why would you need them?

To have renewed tightening, we’d probably have to see the US labour market heat up more. The labour market’s trend towards better supply-demand balance, which Powell has touted in every recent meeting, would probably have to not just stall, but reverse. This would change the calculus for the Fed. Instead of facing two-sided risks to its dual mandate, the risk of higher unemployment would start looking diminished. Like in 2022, inflation-fighting mode would kick in.

So is thinking about rate rises this year bananas? No; it’s a real tail risk. But Summers’ 15 per cent probability strikes me as too high. It’s premature to speak of “mini paradigm shifts”. Markets are pricing in the tail risk more realistically: a 6.3 per cent chance of a quarter-point rate rise in 2024 — closer to getting a false positive on a drug test than missing a 37-yard field goal.

One good read

This piece, by the aforementioned Nick Megaw, on wonky trading in Nvidia-linked stocks, is a good read for you, and for the securities regulator in your life.