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Macro and Market
Fixed Income

Fed, ECB Seek to Temper Markets’ Rate-Cut Expectations

The timetable for executing dovish policy likely will be longer than many investors presume.


Key Takeaways

The Fed and other key central banks remain on hold, awaiting definitive signs that inflation is under control.

Most investors have a more dovish outlook than ours and expect a series of rate cuts that we think are unlikely.

Monetary policy likely will remain restrictive until an economic slowdown unfolds later this year.

The Federal Reserve (Fed) left interest rates unchanged Wednesday, nearly a week after its European counterpart also held rates steady. Most observers expect the Bank of England (BoE) to follow suit at its February 1 meeting.

At its fourth consecutive policy meeting, the Fed kept short-term interest rates at a 23-year high range of 5.25% to 5.5%. The European Central Bank (ECB) left its key refinancing rate at a 22-year high of 4.5% and its deposit facility rate at a record-high 4%. BoE officials will likely hold their benchmark interest rate at 5.25%, a 15-year high.

Still-Strong Data Fuels Fed’s Cautious Approach

Policymakers continue to walk a fine line in their effort to orchestrate a soft landing, which, historically, has been difficult to achieve. Cutting rates too soon could fan inflation while cutting too late could set off a steep recession and trigger job losses.

At his post-meeting press conference, Fed Chair Jerome Powell reiterated the reasons for another policy pause rather than a rate cut:

  • Above-target inflation. As measured by personal consumption expenditures (PCE), annual core inflation (excludes food and energy prices) advanced 2.9% in December. While this pace is lower than in prior months, it’s still above the Fed’s 2% target. And despite shorter-term measures of core PCE on target, policymakers want confidence that annual inflation is headed toward 2% before loosening the monetary policy reins.

  • Solid economic growth. The U.S. economy has displayed surprising resilience, growing 3.3% (annualized) in the fourth quarter and 3.1% in 2023. This unexpected strength amid elevated inflation and interest rates is prompting the Fed to tread carefully. Nevertheless, the Fed does expect growth to moderate in 2024.

  • A robust job market. The labor market has broadly defied expectations, with durable wages and relatively steady job growth. December’s unemployment rate held steady at 3.7%, only slightly higher than a year earlier when it was 3.5%. Private sector wages rose 4.3% in the fourth quarter, compared with 4.5% in the third quarter.1

We don’t foresee a crisis scenario that forces the Fed into a rapid succession of rate cuts.

Market’s Outlook for Near-Term Aggressive Rate Cuts Is Unlikely

The Fed remains eager to restrain investors’ rate-cut jubilation. Officials worry that investors expect rates to drop quickly and dramatically, even as inflation remains above target. Since their December meeting, Fed members have emphasized they will carefully consider the timing and magnitude of rate cuts.

But some investors aren’t buying it. As of late January, the futures market still expected six quarter-point rate cuts starting in May. That’s double the number of cuts the Fed said it’s considering and unlikely in our view.

In recent history, the Fed has rapidly cut interest rates only in times of financial distress:

  • Fed policymakers slashed rates by 1.5 percentage points in two emergency meetings in March 2020 as the COVID-19 crisis unfolded.

  • As the Fed battled the Great Financial Crisis, it hacked rates by 5.25 percentage points between September 2007 and December 2008.

  • The Fed cut rates by 5.25 percentage points in 2001 in response to the bubble burst and the economic fallout from the September 11 terrorist attacks.

We expect an economic slowdown in 2024, with the odds equally split between a recession and below-trend growth. However, we don’t foresee a crisis scenario that forces the Fed into a rapid succession of rate cuts. Instead, we believe Fed policy will remain restrictive until its full effects weave through the economy and weaker growth becomes evident later this year.

As Economies Weaken, European and U.K. Officials Still Confront Persistent Inflation

European and U.K. policymakers face a more challenging task than the Fed. Unlike in the U.S., these central banks are staring down a recession, with gross domestic product (GDP) flat to slightly negative in the last several quarters. At the same time, inflation has remained persistent and above central bank targets.

While the Fed has a dual mandate of maintaining price stability and full employment, the ECB and BoE have a single mandate. Their monetary policy objective is to maintain stable prices.

Eurozone inflation, which climbed off a two-year low to 2.9% in December, had policymakers insisting that rate-cut talk is premature. U.K. inflation rose for the first time in 10 months to 4%, dashing hopes for an early-2024 rate cut.

So far, policymakers have targeted too-high inflation rather than too-low growth. Yet investors are betting on several rate cuts this year.

We expect more clarity from eurozone and U.K. policymakers in the coming months. Their actions tend to lag those of the Fed. We expect the ECB and BoE to begin cutting rates once the Fed starts easing.

John Lovito
John Lovito

Co-Chief Investment Officer

Global Fixed Income

Charles Tan
Charles Tan

Co-Chief Investment Officer

Global Fixed Income

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