Thought of the day

US equity futures rose modestly on Thursday ahead of key inflation data that could influence the Federal Reserve’s thinking on the timing and pace of rate cuts. Both Asian and European stocks traded higher, while the yield on the 10-year Treasury was little changed at around 4%.

While the headline consumer price index (CPI) for December is expected to nudge higher, consensus forecasts point to a further decline in core measures excluding food and energy, which carries more weight in the Fed’s decisions. Core CPI for November held flat at 4% year-over-year, the lowest level since September 2021.

As investors look for further evidence that price pressures in the US are cooling, we think markets’ current pricing of close to a 70% chance of a first rate cut in March may be too optimistic.

Fed officials have pushed back on timing of market expectations on the start of monetary easing. New York Fed President John Williams on Wednesday said it’s too soon to call for rate cuts as the central bank still has some distance to go on getting inflation back to its 2% target. He added that rates need to stay high “for some time,” with inflation likely only hitting the goal in 2025. Earlier this week, Atlanta Fed President Raphael Bostic reiterated his expectation for a first cut to be in the third quarter of this year.

The labor market remains relatively strong amid solid growth. While there are signs of gradual cooling in the labor market, the latest jobs report points to robust job creation. Unemployment is also still close to multi-decade lows. With the fear of unemployment likely to remain relatively contained, in our view, we don't expect a sharp rise in rainy-day savings to present a significant drag on consumer spending in 2024. Instead, we expect spending growth to slow only gradually, consistent with our expectations for a soft economic landing. Household balance sheets also remain strong. This resilient backdrop reduces the need for the Fed to rush into rate cuts, in our view.

Inflation is likely to fall at a more gradual pace. The falling trend in inflation has become well-established. But it is likely that the improvement will slow in the first half of 2024, as year-over-year price comparisons become less favorable. Due to this fading of favorable base effects, it is possible that upcoming inflation could lead to some disappointment among investors. In our view, inflation prints are likely to approach the Fed’s target only in the second half of this year.

So, our base case scenario is for four 25-basis-point rate cuts this year starting in May. We reiterate the need for investors to manage liquidity by limiting cash balances and locking in yields. Although yield volatility is likely to remain high in the near term, we retain a most preferred rating for quality bonds in our global portfolios. We also continue to see quality stocks as a core holding for investors.