[Song Seungseop's Financial Light] Is US Inflation Coming Down? ... Interest Rate Cut Expectations 'Gaining Momentum'

Expectations for Interest Rate Cut in June 2024 at 43%
Market Cheers Over Lower-than-Expected October Inflation

There are talks that the US benchmark interest rate has passed its peak. Just a few weeks ago, people were wondering about the possibility of further rate hikes, and the consensus was that high interest rates would continue for a considerable period. So, what caused the market's expectations to change so rapidly?

Looking at the Chicago Mercantile Exchange's 'FedWatch,' the shift in expectations is clearly visible. FedWatch is an indicator that predicts the US benchmark interest rate based on federal funds futures prices. Simply put, it reflects the market investors' expectations for the future US benchmark interest rate. As of the 25th, the probability that the Federal Reserve (Fed) will keep the current benchmark rate at 5.25?5.50% in the upcoming meeting is 95.5%. The prediction that the rate will be raised by 0.25 percentage points is only 4.5%.

Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), held a press conference after the Federal Open Market Committee (FOMC) meeting ended on the 1st (local time) in Washington, DC. [Image source=Yonhap News]

The timing for a rate cut is expected to be in the second quarter of next year. The opinion that the benchmark rate will be cut at the May meeting stands at 39.7%, slightly lower than the 46.3% probability of it being held steady. For the June meeting, the possibility of a 0.25 percentage point rate cut is 43.0%, significantly surpassing the 26.1% forecast for no change. There is even a 23.8% view that the benchmark rate will be lowered by 0.5 percentage points to 4.75?5.00%.

Financial institutions are also beginning to suggest a rate cut in the second quarter. A report published this month by Morgan Stanley's economic analysis team indicated that the Fed's first rate cut would occur in June 2024. They also analyzed that the benchmark rate would be lowered once more in September. Switzerland's largest investment bank, UBS, even predicted that rate cuts would begin earlier, in March.

Just a month ago, expectations were not this high. FedWatch showed only a 69.1% forecast for the benchmark rate to remain unchanged. Instead, the expectation that it would rise by 0.25 percentage points was as high as 29.3%. For June, the expectation that the benchmark rate would be cut by 0.25 percentage points (35.6%) was slightly lower than the forecast for it to remain steady (35.8%). Experts were similar. Bank of America currently forecasts that rate hikes have ended, but as recently as September, they maintained expectations for further increases.

The change in market outlook is due to the fact that the previously high US inflation is gradually being brought under control. According to the US Department of Labor, the consumer price index (CPI) inflation rate for October was 3.2% year-over-year. This was lower than the market expectation of 3.3%. Compared to the 3.7% CPI inflation rate in September, it was 0.5 percentage points lower. Month-over-month, it was flat, meaning prices in October did not rise compared to the previous month. Expected inflation also decreased from 3.7% in September to 3.6%.

Above all, market participants focused on the core inflation rate. The core inflation rate is calculated excluding volatile items and shows the underlying trend in prices. The core inflation rate for October rose 4% compared to October of the previous year. This was the lowest increase since September 2021 and was also lower than market expectations.

Moreover, there have even been talks of signs of 'deflation' in some sectors. Consumption is a major economic sector supporting the US economy. It is generally said to account for two-thirds of the US economy. However, the most recent data shows that US retail sales in October decreased by 0.1% compared to the previous month. This is the first time in seven months, since March, that US consumption has shown a negative figure. Doug McMillon, CEO of Walmart, even said, "Looking ahead to next year, Walmart in the US could face a deflationary environment."

However, it is advisable to avoid premature investments based on blind faith in the timing of rate cuts. There are concerns that expectations for rate cuts have been excessively reflected in the financial and investment markets. Even during the current rate hike cycle, investors' premature predictions of rate cuts have been repeatedly off the mark. There is also a warning that if excessive expectations cause inflation to rise again, predicting the timing of rate cuts will become difficult.

Jae-kyun Ahn, a researcher at Shinhan Investment Corp., recently warned, "Since last year, when real interest rates stagnated or fell, expected inflation rebounded again," adding, "Because of this, the Fed has at times strengthened its hawkish stance again."