Recently oil prices have been rising, and multiple members of the Federal Reserve are indicating they may oppose interest rate cuts for some time, Consequently, I’m less convinced than I was in previous weeks that the central bank will cut rates by the end of the summer. Still, I continue to believe the Fed may very well lower rates starting in June. Moreover, I think the continued strength of the U.S. economy is likely to lift stocks even if companies’ interest costs are not lowered.
Why the Fed Could Still Cut Rates by July
Until recently, I believed that the chances of the Fed reducing rates by its July meeting were 80% to 90%. Now, I’m lowering those odds to 65% to 75%.
Clearly, Fed Chairman Jerome Powell still wants to lower rates, as he indicated that he continues to believe inflation is heading lower and said the economy’s “overall picture” has not changed. His comments suggest he thinks the central bank remains in line to cut rates three times this year, following the projections it released last month.
Powell also noted the labor market has become “less tight” than in previous years. Another Fed member, Adriana Kugler, recently echoed Powell’s comments.
Also noteworthy is that most Fed members and experts agree the central bank’s current rates are quite “restrictive.” In other words, they are reducing the money supply and, as a consequence, putting downward pressure on both economic expansion and inflation.
Moreover, the Fed has said that the “neutral rate,” i.e., the line that divides restrictive rates from expansionist rates, is 2.6%. With the Fed funds rate currently around 5.35%, the central bank can still lower rates significantly and remain restrictive.
Also noteworthy is that Goldman Sachs (NYSE:GS) Chief Economist Jan Hatzius, whose predictions have generally been quite accurate in recent years, stated on April 5 that he continues to expect the central bank to cut rates three times in 2024.
Why the Chances of Imminent Rate Cuts Have Dropped
Multiple Fed members have reacted to slightly higher-than-expected inflation data by becoming more hawkish. Specifically, Neel Kashkari said he may not support rate reductions this year if inflation does not drop further. Going a step further was Michelle Bowman, who said she could foresee a scenario that would force the central bank to raise rates “at a future meeting.” She added, “Reducing our policy rate too soon or too quickly could result in a rebound in inflation.”
Also importantly, oil has risen about 13% since mid-February, and the prices of other important commodities, including silver and copper, have climbed significantly during the same period. Those increases have put meaningful upward pressure on inflation.
The Importance of Interest Rates Continue to Be Exaggerated
History and recent events continue to show the Street and many economists greatly exaggerate the impact of rates on the economy and stocks.
In 2022 and 2023, many — if not most — economists and Street professionals were sure the Fed’s rate hikes would cause a recession. Of course, no recession materialized, and the U.S. economy has actually grown a great deal last year, while the latter trend is continuing in 2024.
Further, Hatzius, Goldman Sachs’ economist whose forecasts have largely been on target in recent years, expects the U.S. GDP to expand close to 3% in 2024 and puts the risk of a recession within the next year at just 15%.
What’s more, in the late 1990s, the Fed funds rate was often as high or higher than it is now, yet the U.S. economy and stocks both performed very well. For example, in May 1995, the Fed funds rate was 6%, while it was 5,5% in April 1997 and 5.55% in August 1998.
I think stocks could suffer a 10% to 15% correction in the unlikely event that the Fed foregoes rate hikes because some on the Street will panic about rates staying at their current levels.
However, the past suggests the economy can stay strong with rates at their current levels, while it is the economy, not interest rates, that determines companies’ profits and stock prices.
On the date of publication, Larry Ramer did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
