Pristine Inflation Data Is Too Much to Expect

The Federal Reserve is likely to cut policy rates this year less than the market expects, and the latest inflation report shows why. The consumer price index rose 0.3% in December from a month earlier, pushing the six-month annualized rate up to 3.2%, from a previous 2.9%. Although it was basically a fine report, it wasn’t pristine — and the market is priced for pristine.

As of the time of writing, futures trading suggests that the Fed will make roughly six 25 basis-point cuts in 2024. Come on! Fed policymakers — who hate to surprise markets — have done little to prime investors for such an easing cycle, so there’s almost no chance that they will start at the meeting later this month. Federal Reserve Bank of Cleveland President Loretta Mester told Bloomberg’s Michael McKee on Bloomberg TV Thursday that “March is probably too early.” After that, the Fed’s rate-setting committee only has six meetings left in the year, and the market is effectively saying the committee will cut at all of them.

That seems unlikely. When policymakers start cutting, they’re going to do so gingerly and watch developments in the data as they do. Here’s how Mester described her cautious approach in Thursday’s interview:

It’s really going to be dependent on how the economy evolves. I think March is probably too early in my estimation for a rate decline because I think we need to see some more evidence. I think the December CPI report just shows there’s more work to do, and that work is going to take restrictive monetary policy.

Even after policymakers start cutting, the odds are reasonably elevated that something will give them pause at some point, prompting them to go on hold for a while. That “something” could be a bona fide reacceleration of inflation (unlikely, in my view) or a hiccup in the data (quite likely). Hiccups happen all the time in macroeconomic data due to the inherent volatility of prices, measurement challenges and other factors.

A Tiny Bounce