-
We have previously written on why we think that there will not be any rate cuts in 2024, given that the inflation threat remains well alive.
US consumer prices picked up at a faster-than-expected pace in March. US CPI increased 3.5% YoY in March, and this is up from February’s 3.2% increase, marking the highest annual gain in the past six months.
We find the Fed’s projections on the path of monetary policy inconsistent with the outlook for stronger economic growth and higher inflation.
Escalating tensions in Middle East with Iran now getting involved also poses a fresh threat to inflation. In particular, the geographical proximity to Iran to the Strait of Hormuz, an important oil choke point is something to watch for.
We continue to expect the Fed to hold rates this year, meaning that interest rates would stay higher for longer. Within fixed income, we prefer short-duration bonds, while for equities, we have a preference for quality companies and commodity-related stocks.
Optimistic expectations for rate cuts have evaporated. At the start of 2024, the expectation was for six rate cuts this year. Now, it is unravelling in a humbling fashion, and today markets are expecting about one rate cut.
We are not surprised with this sudden change. As after all, we have taken a contrarian view since the end of last year, having published research on this before the substantial change in market expectations.
Related articles:
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iFAST 2024 Investment Outlook: Your must-read guide to navigating markets in 2024 and beyond
The Fed will not cut rates this year. Here’s why.
Fed now signaling delays in interest rate cuts
US consumer prices picked up at a faster-than-expected pace in March. US CPI increased 3.5% year over year (YoY) in March, and this is up from February’s 3.2% YoY increase, marking the highest annual gain in the past six months. The strong pace was driven by upticks in the cost of housing and gasoline. Meanwhile, core inflation stands at 3.8% YoY in March, far from the Fed’s long-term 2% target.
Figure 1: Rising US CPI has caused
some worries
At this point, the fact that inflation has not continued to fall cannot be brushed off as a blip. In response to this, Fed Chair Jerome Powell had even said “the recent data have clearly not given us greater confidence, and instead indicate that it's likely to take longer than expected to achieve that confidence”. Moreover, as they have reiterated before, the Fed would not be cutting rates until they gained greater confidence that inflation was on a steady path back to the central bank’s 2% annual target.
While the Fed has not made any adjustments to its policy rate forecast, and continue to pencil in three rate cuts for this year, markets have. Markets are now expecting one rate cut (Figure 2). We however, reaffirm our view for no rate cuts this year, and for interest rates to stay higher for longer.
Figure 2: Markets are now expecting one rate cut by the Fed in 2024 
Economic resilience keeps the inflation threat alive
The realisation that the interest rate pivot would take some time also comes at a time where the US economy continues its strong performance, something which we have also previously warned about.
Data showed the US economy motoring at an unexpectedly brisk pace. The real gross domestic product (GDP) increased at an annual rate of 3.4% in the fourth quarter of 2023, higher than previous estimates of 3.2%. In the meantime, there are other signs that the economy is expanding more steadily than many predicted, and perhaps beyond the Fed’s expectations. The US economy added 303,000 jobs in March, and there remain approximately 1.4 job vacancies for each unemployed worker in the United States.
Figure 3: US Real GDP growth has
continued to grow strongly 
More importantly the Fed also updated its summary of economic projections, where they made significant upward revisions to their estimates for GDP growth and core PCE – from 1.4% to 2.1%% and 2.4% to 2.6% respectively.
Table 1: Summary of economy projections in March 2024 vs Dec 2023
|
2024 Projections |
March 2024 |
December 2023 |
Change |
|
Real GDP Growth |
2.1% |
1.4% |
+0.6% |
|
Core PCE |
2.6% |
2.4% |
+0.2% |
|
Fed Funds Rate |
4.6% |
4.6% |
- |
|
Source: Federal Reserve Data as of 20 Mar 2024 |
|||
Nevertheless, after the FOMC’s March 2024 meeting, a report released by its members continues to project three cuts to the fed funds rate this year. We thus find the Fed’s projections on the path of monetary policy inconsistent with the outlook for stronger economic growth and higher inflation. This, along with the slew of better-than-expected economic data in recent times reinforces our view that the US economy is doing well, and there is no need for the Fed to cut rates this year. Cutting rates at the time when the economy is doing well, risks stoking inflationary pressures.
Related article: Key takeways from the Federal Reserve and Bank of Japan’s March policy meetings
Recent escalation of Middle East Conflict further supports our view
Recently, tensions in the Middle East have escalated as Iran carried out a response attack on Israel. The event marks a clear escalation of tensions in the region, with Iran now getting involved. In face of rising tensions, Brent Crude reached USD 92.18 on 12 April 2024, the highest levels since October last year.
Moving forward, two risks stand out. First is the risk of a broader conflict, especially as the Middle East as a whole accounts for roughly a third of global oil production. Should others in the region start also start to take sides, the energy supply picture could look more difficult. Second, is the risk of transit disruption. The Strait of Hormuz sees almost 20% of global oil supply and a significant amount of all shipping volumes. Iran’s geographic proximity (Figure 4) to the channel means there is a risk of immobilising supply.
Figure 4: The Strait of Hormuz is vital to the world’s oil supply flows
The current precarious situation in turn has an impact on oil prices. Beyond this, we also expect oil prices to remain at elevated levels, especially as supply remains constrained on the back of OPEC+ continued production cuts where Saudi Arabia and Russia have extended voluntary oil output cuts of 2.2 million barrels per day into the second quarter.
Going forward, there will also be no shortage of geopolitical tensions or conflicts that will continue to impact oil prices. Take the Russia Ukraine war previously, the Israel-Hamas war, Red Sea attacks, the recent Ukrainian attacks on Russia energy facilities and the further escalations in the Middle East conflict. All of which had led to this higher for longer oil price environment which we are currently in.
We turned out to be right. Higher for longer rates are
here to stay
The tone of markets has changed ever since the start of the year. Behind these changes are familiar culprits: inflation and interest rates, against the backdrop of heightened geopolitical risks. The possibility of a widening conflict in the Middle East and rising oil prices need to be carefully watched as they feed into inflation.
We continue to reiterate our view of there being no interest rate cuts this year, and that inflation and interest rates will stay higher for longer. With this in mind, investors should consider investing in the following: (1) opt for short duration bonds for fixed income; (2) invest in quality companies and commodity-related stocks for equities.
Table 2: Recommended products to consider
|
Market / Sector |
Recommended Product |
|
Short duration bonds |
Nikko AM Shenton Short Term Bond SGD |
|
United SGD Fund Cl A Acc SGD |
|
|
Quality companies |
JPMorgan US Quality Factor ETF (NYSE:JQUA) |
|
Commodity-linked equities |
Blackrock Natural Resources Growth & Income A2 USD |
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