GDP, Inflation, and the Fed: Keep Calm and Carry On

The reaction from markets to the release of Q1 2024 real GDP results has given every sector of the market another chance to give their own interpretation of what is coming regarding Federal Reserve (Fed) policy, inflation, and the federal funds rate. We have already started to hear that the Fed is not going to cut rates at all during the year; that it is only going to cut twice, or just once; that we are going into a stagflation process (we thought we had made the case clear that the current process has no similarities to the stagflation process of the 60s, 70s, and early 80s), just because of a worse than expected quarterly PCE price index number; that we are going into a recession because the yield curve has been inverted for too long, etc. In fact, the latter group – yield curve inversion group – has been consistent over time.

The only problem with some of this group’s thinking today is that while in the past they have argued for a recession and immediate interest rate cuts by the Fed, they seem to have jumped onto the ‘stagflation’ bandwagon, which argues that we will have a recession but with much higher inflation and no rate cuts. And then, there are those calling for the Fed to actually increase interest rates under the argument that it stopped rising interest rates too early.

What is important to remember is that this was the same market that was pricing in seven interest rate cuts in 2024 just four months ago!!

implied fed funds

It is true that the rate of inflation during the first quarter of the year is not what markets were expecting, but we always said that the last stretch of the disinflationary process was going to be a long one. The Fed knows this, that is the reason why it expects to hit the 2% target in 2026, not today, not this year, not even in 2025. There is plenty of time for Fed policy to work its magic and the Fed has positioned itself to do that. It is true that the worse than expected result in the first quarter may delay the decision to start cutting interest rates to later this year. Please see the section on the following page where we discuss our changes. The truth is that nothing else has really changed from what we were expecting earlier this year or even last year.