U.S. Federal Reserve does not expect to cut interest rates until it’s confident about inflation

Richard Schmidt

February 1, 2024

Key takeaways

  • The target range for the federal funds rate remains at 5.25-to-5.5%.
  • Inflation continues to ease but remains elevated.
  • Interest rate hikes are likely off the table and the U.S. Federal Reserve is considering rate cuts. 

At the conclusion of the first Federal Open Market Committee (FOMC) meeting of the year, the U.S. Federal Reserve (Fed) announced that it would hold the target range for the federal funds rate at 5.25-to-5.5%. It will also continue reducing its holdings of Treasuries, agency debt and agency mortgage-backed securities. The decision was unanimously agreed upon by all voting members of the FOMC and was widely anticipated by market participants.

While the results were the same, the Fed did make changes to its statement. Taking the place of warnings of possible additional rate hikes was the Fed’s updated positioning that “the Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.”

U.S. economic growth remains solid and inflation is easing

Taken from the Fed’s latest statement, “Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have moderated since early last year but remain strong, and the unemployment rates has remained low. Inflation has eased over the past year but remains elevated.”

As a reminder, the Fed estimated in its December Summary of Economic Projections that U.S. economic growth would be 1.4% in 2024, 1.8% in 2025 and 1.9% in 2026. Similarly, the Fed expects inflation of 2.4% in 2024, 2.2% in 2025 and 2.0% in 2026.

The rate cut waiting game

The Fed’s median interest rate estimates from December (4.6% in 2024, 3.6% in 2025 and 2.9% in 2026) would suggest three cuts this year, totaling 0.75%. More aggressive market estimates have the Fed cutting rates up to six times in 2024, totaling 1.5%.

Our expectations are leaning towards the more conservative estimates. Whatever the case, it’s clear that the Fed is now waiting for circumstances that will satisfy its conditions of inflation “moving sustainably toward 2%.” We expect the Fed to begin easing monetary policy by cutting interest rates in the second half of the year.

Scotia Global Asset Management’s Multi-Asset Management Team remains cautious at this time

While we recently increased our allocation equities in our portfolios that include a tactical asset allocation overlay, we remain underweight overall relative to fixed income. The cumulative impact of higher rates is still very much playing out and remains a negative for assets like equities. Our bear market signals also continue to flag red, indicating an increased risk of recession, justifying our tactical positioning.

Going beyond being tactically overweight fixed income, we’ve taken the opportunity to benefit from a decreased in bond yields in anticipation of central banks cutting rates. Evidence and the shift in interest rate expectations suggests the current level of monetary policy restriction is likely no longer required.

The Fed’s next interest rate announcement is scheduled for March 20th.

Richard Schmidt

Richard Schmidt, CFA, is an Associate Portfolio Manager with the Multi-Asset Management Team of Scotia Global Asset Management. His primary focus is on North American equity funds and pools.