Economics
Hot inflation data pushes market’s rate cut expectations to September
Traders work on the floor of the New York Stock Exchange during afternoon trading on April 09, 2024 in New York City.
Michael M. Santiago | Getty Images
As recently as January, investors had high hopes that the Federal Reserve was about to embark on a rate-cutting campaign that would reverse some of the most aggressive policy tightening in decades.
Three months of inflation data have brought those expectations back down to earth.
March’s consumer price index report Wednesday helped verify worries that inflation is proving stickier than thought, giving credence to caution from Fed policymakers and finally dashing the market’s hopes that the central bank would be approving as many as seven rate cuts this year.
“The math suggests it’s going to be hard near term to get inflation down to the Fed’s target,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “Not that you’ve put a pin in inflation getting to the Fed’s target, but it’s not happening imminently.”
There was little good news to come out of the Labor Department’s CPI report.
Both the all-items and ex-food and energy readings were higher than the market consensus on both a monthly and annual basis, putting the rate of inflation well above the Fed’s target. Headline CPI rose 0.4% on the month and 3.5% from a year ago, ahead of the central bank’s 2% goal.
Danger beneath the surface
But other danger signs beyond the headline numbers emerged.
Services prices, excluding energy, jumped 0.5% and were up 5.4% from a year ago. A relatively new computation the markets are following which takes core services and subtracts out housing — it has come to be known as “supercore” and is watched closely by the Fed — surged at an annualized pace of 7.2% and rose 8.2% on a three-month annualized basis.
There’s also another risk in that “base effects,” or comparisons to previous periods, will make inflation look even worse as energy prices in particular are rising after falling around the same time last year.
All of that leaves the Fed in a holding position and the markets worried about the possibility of no cuts this year.
The CME Group’s FedWatch tool, which computes rate-cut probabilities as indicated by futures market pricing, moved dramatically following the CPI release. Traders now see just a slim chance of a cut at the June meeting, which previously had been favored. They have also pushed out the first reduction to September, and now expect only two cuts by the end of the year. Traders even priced in a 2% probability of no cuts in 2024.
“Today’s disappointing CPI report makes the Fed’s job more difficult,” said Phillip Neuhart, director of market and economic research at First Citizens Bank Wealth. “The data does not completely remove the possibility of Fed action this year, but it certainly lessens the chances the Fed is cutting the overnight rate in the next couple months.”
Market reaction
Markets, of course, didn’t like the CPI news and sold off aggressively Wednesday morning. The Dow Jones Industrial Average dropped by more than 1%, and Treasury yields burst higher. The 2-year Treasury note, which is especially sensitive to Fed rate moves, jumped to 4.93%, an increase of nearly 0.2 percentage point.
There could yet be good news ahead for inflation. Factors such as rising productivity and industrial capacity, along with slower money creation and easing wages, could take the pressure off somewhat, according to Joseph LaVorgna, chief economist at SMBC Nikko Securities.
However, “inflation will remain higher than what is necessary to warrant Fed easing,” he added. “In this regard, Fed cuts will be pushed out to into the second half of the year and are likely to fall only 50 basis points [0.5 percentage point] with risks being tilted in the direction of even less easing.”
In some respects, the market has only itself to blame.
The pricing in of seven rate cuts earlier this year was completely at odds with indications from Fed officials. However, when policymakers in December raised their “dot plot” indicator to three rate cuts from two projected in September, it set off a Wall Street frenzy.
“The market was just way over its skis in that assumption. That made no sense based on the data,” Schwab’s Sonders said.
Still, she thinks if the economy stays strong — GDP is projected to grow at a 2.5% rate in the first quarter, according to the Atlanta Fed — the knee-jerk reaction to Wednesday’s data could pass.
“If the economy hangs in there, I think the market is, for the most part, OK,” Sonders said.
Correction: The markets are worried about the possibility of no cuts this year. An earlier version misstated the worries.
Production at the VW plant in Emden.
Sina Schuldt | Picture Alliance | Getty Images
The struggling German economy has been a major talking point among critics of Chancellor Olaf Scholz’ government during the latest election campaign — but analysts warn a new leadership might not turn these tides.
As voters prepare to head to the polls, it is now all but certain that Germany will soon have a new chancellor. The Christian Democratic Union’s Friedrich Merz is the firm favorite.
Merz has not shied away from blasting Scholz’s economic policies and from linking them to the lackluster state of Europe’s largest economy. He argues that a government under his leadership would give the economy the boost it needs.
Experts speaking to CNBC were less sure.
“There is a high risk that Germany will get a refurbished economic model after the elections, but not a brand new model that makes the competition jealous,” Carsten Brzeski, global head of macro at ING, told CNBC.
The CDU/CSU economic agenda
The CDU, which on a federal level ties up with regional sister party the Christian Social Union, is running on a “typical economic conservative program,” Brzeski said.
It includes income and corporate tax cuts, fewer subsidies and less bureaucracy, changes to social benefits, deregulation, support for innovation, start-ups and artificial intelligence and boosting investment among other policies, according to CDU/CSU campaigners.
“The weak parts of the positions are that the CDU/CSU is not very precise on how it wants to increase investments in infrastructure, digitalization and education. The intention is there, but the details are not,” Brzeski said, noting that the union appears to be aiming to revive Germany’s economic model without fully overhauling it.
“It is still a reform program which pretends that change can happen without pain,” he said.
Geraldine Dany-Knedlik, head of forecasting at research institute DIW Berlin, noted that the CDU is also looking to reach gross domestic product growth of around 2% again through its fiscal and economic program called “Agenda 2030.”
But reaching such levels of economic expansion in Germany “seems unrealistic,” not just temporarily, but also in the long run, she told CNBC.
Germany’s GDP declined in both 2023 and 2024. Recent quarterly growth readings have also been teetering on the verge of a technical recession, which has so far been narrowly avoided. The German economy shrank by 0.2% in the fourth quarter, compared with the previous three-month stretch, according to the latest reading.
Europe’s largest economy faces pressure in key industries like the auto sector, issues with infrastructure like the country’s rail network and a housebuilding crisis.
Dany-Knedlik also flagged the so-called debt brake, a long-standing fiscal rule that is enshrined in Germany’s constitution, which limits the size of the structural budget deficit and how much debt the government can take on.
Whether or not the clause should be overhauled has been a big part of the fiscal debate ahead of the election. While the CDU ideally does not want to change the debt brake, Merz has said that he may be open to some reform.
“To increase growth prospects substantially without increasing debt also seems rather unlikely,” DIW’s Dany-Knedlik said, adding that, if public investments were to rise within the limits of the debt brake, significant tax increases would be unavoidable.
“Taking into account that a 2 Percent growth target is to be reached within a 4 year legislation period, the Agenda 2030 in combination with conservatives attitude towards the debt break to me reads more of a wish list than a straight forward economic growth program,” she said.
Franziska Palmas, senior Europe economist at Capital Economics, sees some benefits to the plans of the CDU-CSU union, saying they would likely “be positive” for the economy, but warning that the resulting boost would be small.
“Tax cuts would support consumer spending and private investment, but weak sentiment means consumers may save a significant share of their additional after-tax income and firms may be reluctant to invest,” she told CNBC.
Palmas nevertheless pointed out that not everyone would come away a winner from the new policies. Income tax cuts would benefit middle- and higher-income households more than those with a lower income, who would also be affected by potential reductions of social benefits.
Coalition talks ahead
Following the Sunday election, the CDU/CSU will almost certainly be left to find a coalition partner to form a majority government, with the Social Democratic Party or the Green party emerging as the likeliest candidates.
The parties will need to broker a coalition agreement outlining their joint goals, including on the economy — which could prove to be a difficult undertaking, Capital Economics’ Palmas said.
“The CDU and the SPD and Greens have significantly different economic policy positions,” she said, pointing to discrepancies over taxes and regulation. While the CDU/CSU want to reduce both items, the SPD and Greens seek to raise taxes and oppose deregulation in at least some areas, Palmas explained.
The group is nevertheless likely to hold the power in any potential negotiations as it will likely have their choice between partnering with the SPD or Greens.
“Accordingly, we suspect that the coalition agreement will include most of the CDU’s main economic proposals,” she said.
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