Why The Fed Will Cut Rates This Year

The US economy managed to grow 3.3% during the fourth quarter compared to 4.9% growth in the third quarter. Clearly economic activity slowed a bit toward the end of the year, but remains far more robust than most economists and investors anticipated. Remember, 2% annual growth is considered healthy. In addition, the report’s inflation gauge slowed to 1.5%, which is great news.

Another recent report showed that the Federal Reserve’s preferred inflation gauge (“PCE Deflator”) slowed to 2.6% vs. 4.9% a year ago. And stripping out food & energy, the Core PCE Deflator slowed to 2.9%, the lowest rate of price growth since March 2021. No matter how you look at it, consumer spending and wages are growing faster than inflation.

But while the economy is generally healthy, we note some odd contradictions in the data. For instance, according to the Bureau of Labor Statistics the number of open job positions in the US ticked up to 9 million last month. That’s not only above most economists’ projections, but also a three-month high. And yet, fewer workers are quitting their jobs, likely due to concern they won’t be able to find new positions at higher wages.

Likewise, consumer confidence has trended sharply higher since October, but much of the improvement pertains to a portion of the survey measuring how consumers feel about current conditions. They’re still somewhat jittery about the future.

Finally, while the GDP report was uniformly positive, we acknowledge some recent business activity surveys hinting at weakness. The Dallas Federal Reserve Bank’s Business Activity Index fell sharply this month, and has been very blah for 18 months now. Other Fed surveys in Philadelphia, Richmond, New York City and Kansas City mirror that weakness, especially for manufacturers.

It seems likely that higher interest rates are beginning to take a toll on smaller businesses and less-affluent consumers. The issues are not felt economy-wide, but are nonetheless beginning to be felt. And this—along with lower inflation—is the reason why the Federal Reserve is considering cutting interest rates this year. Whether that process begins in March or May, it is surely coming.