Macro Signposts | 11 April 2024

Unless explicitly stated, views expressed do not constitute official PIMCO views.

Fed Cuts: Is December the New June?

The U.S. economy's resilience suggests the Federal Reserve's normalization of interest rates may not start until later in 2024, not in June as many observers and investors had been expecting.

The Fed's dual mandate directs it to seek maximum levels of employment and price stability. It's doing fine on the job front: The U.S. economy added 303,000 nonfarm jobs in March, the Bureau of Labor Statistics (BLS) reported on 5 April, far above the consensus estimate of 214,000. The unemployment rate decreased to 3.8% from 3.9% in February.

Inflation tells another story. On 10 April, the BLS reported a 0.38% rise in March's consumer price index (CPI), slightly above expectations and part of an unsettling trend. Excluding more volatile food and energy prices, the net 3-month annualized core CPI inflation rate is now above 4.5%. More concerning, one of the Fed's preferred core measures – inflation in services not including shelter – accelerated to 8% on a net 3-month annualized basis. (For details, please read our blog post, "Persistent Inflation Pressures Could Delay Fed Action.")

Although inflation has moderated considerably from its 2022 peak, the "last mile" decline from above 3% down to 2% (the Fed's target, as measured by personal consumption expenditures or PCE) could be slow and bumpy, likely requiring an economic and labor market cooldown.

Markets were quick to respond to the CPI data, signaling a much lower likelihood of a Fed rate cut in June or July than previously priced.

The confidence factor
Following its meeting in January, the Fed said in a statement that it wouldn't cut rates until officials "gained greater confidence" that inflation was moving sustainably back to 2%. At the time, its median projection of rates foresaw 75 basis points of cuts by December 2024. This was widely interpreted as indicating that the Fed would begin to reduce the fed funds rate in June, and continue doing so at every other meeting. Implicit in this forecast was an expectation of two more quarters with inflation data in the "two-point-something" zone, after 2% quarterly annualized core inflation in the back half of 2023.

However, inflation has reaccelerated since then. Firmer inflation prints in 1Q likely lifted 1Q 2024 core PCE to 3.4% on a seasonally adjusted annualized basis, by our estimates based on current indicators (we will get the official reading from data released later this month). Absent surprisingly weak prints in the next few months, it appears that 2Q core PCE inflation could also run around 3%.

All of this is to say that if the January test for the Fed to "gain greater confidence" was two more consecutive quarters of below-3% quarterly core PCE inflation, then sometime past midyear (perhaps two more quarters, i.e., possibly December) now appears obvious as a much more reasonable time frame for the first cut.

Base case: one rate cut in 2024?
Of course, there are caveats to the simple logic discussed above. The Fed appeared to adjust its inflation confidence rule at the March meeting, by writing off the 1Q PCE reading as being driven by one-off price adjustments at the beginning of the year. This seemed to suggest to the Fed that if core PCE moderated below 3% in 2Q, that would be enough for a June rate cut. Monthly core PCE inflation readings would need to average 0.23% or less for the quarterly pace to fall below 3%. However, looking at broader data, we see good reasons why inflation could very well be hotter than that.

• First, U.S. real GDP continues to grow above potential, casting doubt on inflation falling to the Fed's 2% target. Although immigration and other supply-side factors inject some uncertainty over potential growth levels (for details, see our 15 November 2023 Macro Signposts, "Immigration: a Remedy for Inflation?"), we would argue that 3% growth in final domestic demand rules out a return to target. Indeed, if our tracking estimate of slightly above 3% demand growth in 1Q 2024 is correct, it will mark the third sequential quarter of 3% or above.
• Second, while U.S. labor market imbalances have eased, the market remains tight, with wage inflation running between 4% and 4.5%. The ratio of vacancies to unemployment – a measure of labor demand versus supply – has declined since the post-pandemic days of peak labor scarcity, yet still remains above pre-pandemic levels. Recently, the largest companies – which have increased their concentration of industry revenues over the years, and tend to set wages – have increased their openings to well above pre-pandemic levels.
• Third, immigration may be distorting recessionary signals from the BLS household labor market survey. That survey is not designed to capture real-time fluctuations in immigration of the sort seen in recent years. The survey's inability to capture real-time population growth has, in turn, skewed its estimates for the levels of the labor force, employment, and unemployment. This has resulted in a large gap between the household survey and its higher-sample-size companion survey based on reported hiring at establishments.
• Fourth, unlike in many of America's developed market peers, higher central bank policy rates have been slower to pass through to consumers. For instance, Canada has had stagnant to slightly contractionary growth for over a year now, in part because almost all of its mortgage debt rolls over within five years. (In contrast, 30-year fixed rate mortgages are common in the U.S.) As a result of its below-trend growth (and higher unemployment), Canadian inflation appears on track to more sustainably achieve levels consistent with the central bank mandate.
• Fifth, bottom-up factors driving inflation have intensified, particularly in commodities. For example, steel price inflation has accelerated – a potential harbinger of higher new and used car prices a quarter or two down the road. Inflation has also affected jet fuel prices, which tend to dictate airfares. Even prices for cotton, which are passed on to varying degrees, suggest that the deflationary trends in goods prices are behind us. If core PCE averages 0.2% month-over-month for the rest of the year, the Fed will need to revise up its 2024 core PCE inflation forecast to 2.8% from 2.6% projected in March.

Where things stand
All of this suggests that not only does the U.S. economy not need easier central bank policy, it actually may need some tightening in financial conditions to cool demand and moderate inflation. Talking about rate hikes, however, is still likely a bridge too far for the Fed; that said, by pushing out cuts relative to what is priced into the forward interest rate curve, the Fed can seek to ensure financial conditions remain tighter for longer.

Finally, a word about the election: Yes, the election calendar matters. There is no doubt in our minds that the Fed is apolitical. A historical analysis of Fed moves (even when compared with Taylor Rule prescriptions) suggests that the Fed ultimately has done what it believes is right for the economy regardless of the electoral calendar.

Nevertheless, because Fed officials may want to go out of their way to appear apolitical, the election calendar does matter. Announcing a notable policy pivot (i.e., the first cut) in September, for example, in the heart of the election campaign season, is something the Fed would probably rather avoid – especially if economic growth remains strong, and inflation sticky. Similarly, a cut at the November meeting, which is two days after the election, is probably a non-starter – we doubt the Fed would want to compound the possibility of heightened market volatility following Election Day.

Where does that leave us? Collectively, recent U.S. economic data bolster our view (shared in our recent Cyclical Outlook, "Diverging Markets, Diversified Portfolios") that the Fed will likely ease monetary policy at a more gradual pace than its counterparts in other developed market economies and versus what it was forecasting in March. When Fed officials release their next economic projections in June, they will likely once again revise up their 2024 estimates for both inflation and the median rate path.

Depending on the flow of data, the above factors could present a case for the Fed to delay an initial rate cut past midyear, even though midyear has seemed to be its clear preference based on recent communications. Also, in June the central bank will have a chance to shape expectations via a revised "dot plot" of policy rate projections, even if (as we expect) no cut is forthcoming at that meeting. At that time we think there is a strong case for the Fed to take out one or even two of the cuts projected for the year. Certainly, cooler inflation or a weaker labor market would change the outlook. However, at a minimum, the Fed may need to start communicating this later-and-slower approach in order to sufficiently tighten financial conditions. In other words, with a strong economy, there is no need to rush.

Read the previous edition of Macro Signposts featuring key takeaways from PIMCO's latest Cyclical Outlook.

We welcome your questions about the global macro landscape. Don't hesitate to suggest themes or data for us to analyze and discuss: Please email [email protected].

For regular insights on U.S. policy via email, please write to [email protected] and ask to receive the Washington Watch.

All investments contain risk and may lose value.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. Outlook and strategies are subject to change without notice.

This material contains the current opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission | PIMCO Europe Ltd (Company No. 2604517, 11 Baker Street, London W1U 3AH, United Kingdom) is authorised and regulated by the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. | PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963, via Turati nn. 25/27 (angolo via Cavalieri n. 4), 20121 Milano, Italy), PIMCO Europe GmbH Irish Branch (Company No. 909462, 57B Harcourt Street Dublin D02 F721, Ireland), PIMCO Europe GmbH UK Branch (Company No. FC037712, 11 Baker Street, London W1U 3AH, UK), PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E, Paseo de la Castellana 43, Oficina 05-111, 28046 Madrid, Spain) and PIMCO Europe GmbH French Branch (Company No. 918745621 R.C.S. Paris, 50–52 Boulevard Haussmann, 75009 Paris, France) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 15 of the German Securities Institutions Act (WpIG). The Italian Branch, Irish Branch, UK Branch, Spanish Branch and French Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) (Giovanni Battista Martini, 3 - 00198 Rome) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland (New Wapping Street, North Wall Quay, Dublin 1 D01 F7X3) in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN); (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) (Edison, 4, 28006 Madrid) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively and (5) French Branch: ACPR/Banque de France (4 Place de Budapest, CS 92459, 75436 Paris Cedex 09) in accordance with Art. 35 of Directive 2014/65/EU on markets in financial instruments and under the surveillance of ACPR and AMF. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2, Brandschenkestrasse 41 Zurich 8002, Switzerland). The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (8 Marina View, #30-01, Asia Square Tower 1, Singapore 018960, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited (Suite 2201, 22nd Floor, Two International Finance Centre, No. 8 Finance Street, Central, Hong Kong) is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. PIMCO Asia Limited is registered as a cross-border discretionary investment manager with the Financial Supervisory Commission of Korea (Registration No. 08-02-307). The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Investment Management (Shanghai) Limited. Office address: Suite 7204, Shanghai Tower, 479 Lujiazui Ring Road, Pudong, Shanghai 200120, China (Unified social credit code: 91310115MA1K41MU72) is registered with Asset Management Association of China as Private Fund Manager (Registration No. P1071502, Type: Other). | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862. This publication has been prepared without taking into account the objectives, financial situation or needs of investors. Before making an investment decision, investors should obtain professional advice and consider whether the information contained herein is appropriate having regard to their objectives, financial situation and needs. To the extent it involves Pacific Investment Management Co LLC (PIMCO LLC) providing financial services to wholesale clients, PIMCO LLC is exempt from the requirement to hold an Australian financial services licence in respect of financial services provided to wholesale clients in Australia. PIMCO LLC is regulated by the Securities and Exchange Commission under US laws, which differ from Australian laws. | PIMCO Japan Ltd, Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No. 382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association, The Investment Trusts Association, Japan and Type II Financial Instruments Firms Association. All investments contain risk. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Taiwan Limited is an independently operated and managed company. The reference number of business license of the company approved by the competent authority is (112) Jin Guan Tou Gu Xin Zi No. 015. The registered address of the company is 40F., No.68, Sec. 5, Zhongxiao East Rd., Xinyi District, Taipei City 110, Taiwan (R.O.C.), and the telephone number is +886 2 8729-5500. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | Note to Readers in Colombia: This document is provided through the representative office of Pacific Investment Management Company LLC located at Carrera 7 No. 71-52 TB Piso 9, Bogota D.C. (Promoción y oferta de los negocios y servicios del mercado de valores por parte de Pacific Investment Management Company LLC, representada en Colombia.). Note to Readers in Brazil: PIMCO Latin America Administradora de Carteiras Ltda.Av. Brg. Faria Lima, 3477 Itaim Bibi, São Paulo - SP 04538-132 Brazil. Note to Readers in Argentina: This document may be provided through the representative office of PIMCO Global Advisors LLC AVENIDA CORRIENTES, 299, Buenos Aires, Argentina. | No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America LLC in the United States and throughout the world. ©2024, PIMCO.

CMR2024-0411-3506199