The market continues to estimate the chance of a rate cut in 2025, which could be a big mistake. Although inflation has come down from its COVID-19 highs, it remains hot and uncooperative. Even if the January and February data are weaker than expected, the inflation trend is flat, not downward, and is not consistent with the idea of lower interest rates. Other factors indicating higher interest rates are labor markets, consumer spending, oil prices, GDP forecasts, and the 10-year Treasury. Here’s a look at why.
The Fed’s powers are not in balance
The Fed’s mandate is twofold: support the economy while protecting the labor market and keeping interest rates low. The trend in inflation data is undeniable: it is not cooperating, and the trend in labor data is one reason. The labor market has slowed since its peak in 2022/2023. However, they remain healthy, strong, and resilient, with job gains averaging 191,000 jobs in 2024, unemployment averaging 4%, wages rising 4%, jobs plentiful, and unemployment claims historically low.
Some red flags include Challenger, Gray and Christmas data on layoffs, hiring plans and total unemployment claims data. However, they are better than they seem at face value, as they reveal fluctuations in a changing labor market environment rather than deteriorating conditions.
Consumer trends in 2024 are equally strong. They are expected to achieve gains of more than 3% compared to the previous year. This is enough to outpace core consumer inflation growth compared to the PCE price index, indicating a slight increase in demand. Forecasts for 2025 are for retail sales to accelerate to 3.5% or higher, adding upward pressure on prices, and tailwinds may develop in the back half as Trump’s policy takes effect. Coincidentally, the FOMC noted the same fact at its last meeting.
Rising oil prices: to drive inflation gains in the first quarter
Oil prices exacerbate inflation, affecting input costs at every level of the system. Oil prices fell in 2024, reaching a long-term low in the fourth quarter, but they rebounded strongly. It is 17% below its mid-January lows, which is indicated by price action and indicators, including moving averages, stochastics and MACD. The price of WTI is trading near $78.25, in line with the midpoint of a multi-year trading range with plenty of room to move higher. The bottom line is that oil prices will lead to inflation in the first quarter and potentially during the year, assuming there is no price correction.
the CME FedWatch toolThe Fed’s probability gauge based on futures still points to a chance of cuts in 2025, but the odds are falling sharply. According to her, the reduction is unlikely to occur before July, and a reduction by the end of the year is doubtful. At 75%, it wouldn’t take much more than that to cement the idea of no cuts this year in the market’s mind, an event that would likely trigger a stock market correction. The good news is that the S&P 500 NYSEARCA: SPY The correction is unlikely to lead to a sustained decline due to the underlying economic health, which is the reason behind the rise in inflation.
The ten-year cabinet adapts to a higher environment for a longer period than expected
The 10-year Treasury yield is rising and in line with the Federal Open Market Committee’s expectations. Yield advanced significantly in the first two weeks of the year, rising to an 18-month high supported by the short-term 30-day EMA and the longer-term 150-day EMA. The yield is likely to continue rising because the spread at 4.8%, compared to the FOMC’s expected year-end base rate of 4%, is well below the long-term average. In this environment, yields could rise another 40 basis points or more before peaking, and a Fed cut to 4% is questionable.
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