Last December bond traders and the Federal Reserve agreed to disagree.
The Federal Reserve projected three or four potential .25% reductions in its overnight interest rate target by the end of 2024. Bond traders projected six or seven rate cuts. This disagreement went back and forth in January, but tilted heavily in the Federal Reserve’s favor after the January Consumer Price Index indicated inflation rose.
As much as Wall Street (want lower interest rates) and the White House (want to get re-elected) would like us to believe that inflation has been conquered, the battle may not be over. Taming inflation went very well early in the fight – dropping from almost 9% in summer 2022 to 4% by October 2023. However, since October the core inflation reading (excluding food and energy) has held steady. There has been zero progress over the last three months in moving inflation from 4% closer to the Federal Reserve’s 2% target.
The Federal Reserve’s worst nightmare is to grasp defeat from the jaws of victory by reducing interest rates too soon which could allow inflation to reignite. Yet, it would be really beneficial to reduce interest rates before the fall elections to boost the economy.
This tussle between the Federal Reserve and bond traders could create additional volatility in the financial markets until inflation reading cool further.