Recent documents from the Federal Reserve suggest that interest rate cuts might be delayed until 2026.
In a paper released last week, two economists from the Federal Reserve Bank of Kansas City, Johannes Matschke and Sai Sattiraju, said that the Federal Reserve would need to maintain higher interest rates (above 5%) for a longer period than the market had anticipated, potentially until 2026, to bring inflation down to 2%.
The economists observed that despite the Federal Reserve tightening policies at the fastest pace since the 1980s last year, a surge in inflation propelled the equilibrium level of interest rates in the U.S. economy to rise even more rapidly. Consequently, the policy interest rate level did not enter a restrictive range until the first quarter of 2023.
Recent data indicates that the annualized growth rate of the U.S.'s GDP in the first quarter was 2%. Economists believe that given the robust growth of the U.S. economy, the Federal Reserve may need to maintain the interest rate at its current level or higher for over three years to return its preferred inflation indicator - the core PCE index - to the Federal Reserve's target level of 2%.
Torsten Slok, chief economist at Apollo Global Management, noted that this could complicate the stock market's surge in the first half of the year, causing the S&P 500 Index to give back some of its nearly 16% gain this year, as investors gradually digest the view that "interest rates will not decline soon."
The FedWatch, a Federal Reserve observer tool from the Chicago Mercantile Exchange (CME), shows that traders expect the Federal Reserve to raise interest rates at least one more time this year.
The Federal Reserve has expressed similar sentiments. On June 28, during a central bank forum held by the European Central Bank, Federal Reserve Chair Jerome Powell indicated that the Federal Reserve might raise interest rates as early as next month, not ruling out the possibility of interest rate hikes at two consecutive meetings. He reiterated that the majority of Federal Reserve policymakers forecasted that they expect to raise interest rates at least two more times this year.
During a hearing last week, Powell also stated he does not anticipate the inflation rate returning to the Federal Reserve's 2% target before 2025, implying that the Federal Reserve won't cut interest rates for some time after that. However, federal funds futures market trades show that traders again refused to believe him and instead expect the Federal Reserve to cut interest rates in 2024.
