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- Investors are starting to take seriously the idea that the Fed might not cut interest rates in 2024.
- Strong job gains and elevated inflation reports could put the Fed in a difficult spot later this year.
- At this point, investors are viewing economic strength as ultimately good news for the stock market, if that means a recession is delayed.
From seven, to three, to now potentially zero, projected interest rate cuts in 2024 are quickly going out of style on Wall Street.
Just a few months ago, evidence of fast-falling inflation suggested that the Federal Reserve could get aggressive in normalizing interest rates this year, with initial market projections suggesting the Fed would lower the effective Fed Funds rate to 3.5% by the end of the year from its current level of just above 5.25%.
But a series of strong economic data over the past few months — flanked by solid jobs reports, a pick-up in manufacturing activity, and a strong first-quarter GDP forecast of 2.5% from the Atlanta Fed — suggest that investors will have to wait a bit longer for lower interest rates.
Talk of no 2024 rate cuts growing
That thinking came to a head on Thursday when Minneapolis Fed President Neel Kashkari said there's no reason to cut interest rates when the economy is doing so well.
"If we have a run rate that's very attractive, people have jobs, businesses are doing well, inflation is coming back down, why do anything?" Kashkari asked.
Fed Governor Michelle Bowman echoed similar sentiments on Friday and said said that an additional rate hike, not cut, could be necessary this year if inflation remains above the Fed's long-term target of 2%.
"While it is not my baseline outlook, I continue to see the risk that at a future meeting we may need to increase the policy rate further should progress on inflation stall or even reverse," Bowman said.
The back-and-forth talk of Fed members this week sparked a sizable sell-off on Thursday following Kashkari's comments, though those losses were largely recovered in Friday's trading session following a strong March jobs report.
Still, according to market veteran Ed Yardeni, investors may be finally waking up to the fact that the interest-rate cuts seen as a slam dunk earlier this year may ultimately be off the table in 2024.
"Investors might be finally discounting the possibility of a no-show rate cut this year," Yardeni said in a note on Thursday, adding that the recent rise in oil prices represents an upside risk to inflation.
Other experts arguing for no rate cuts this year include top economists like Mohamed El-Erian, who said last month that the Fed should wait "a couple years" before cutting interest rates due to sticky inflation, and Torsten Slok, who warned that a frenzy for AI stocks would make it difficult for the Fed to cut interest rates.
"We are absolutely in an AI bubble, and the side effect of that is that when tech stocks go up, it eases financial conditions. That's making the job a lot harder for the Fed," Slok said.
The futures market currently assigns a 51% probability of the first interest rate cut happening in June, and analysts at Bank of America said if the first cut doesn't happen in June, it's unlikely to happen at all in the second half of the year as the 2024 Presidential Election approaches.
"If the Fed tells markets that a rate cut is not justified in June, it will be difficult to justify a cut later this year," Bank of America said earlier this week.
Stock market implications
Falling interest rates are a tailwind for stock prices, as they lower the discount rate that is often used to value stocks, leading to higher valuation multiples. So a delay in interest rate cuts, on paper, would suggest lower stock prices.
But what ultimately drives stock prices in the long term is earnings growth. And better-than-expected first quarter profits have helped put a floor on a stock market that is trading near record highs, even as talks of interest rate cuts fade.
Rosy growth outlooks driven by an economy at full employment and efficiency gains driven by the growing adoption of artificial intelligence suggest that stock prices could continue to rise even if interest rates stay elevated, according to billionaire investor Ken Fisher.
And if the stock market and economy do withstand higher interest rates for longer, it will give the Federal Reserve more ammunition to significantly cut interest rates in a bid to stimulate the economy whenever the next inevitable recession arrives.
Ultimately, good news in the economy appears to be good news in the stock market for as long as a recession is averted.