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After soft U.S. CPI, is Fed rate cut wishful thinking?

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Markets are busy wishful thinking about the Federal Reserve cutting interest rates after U.S. inflation eased slightly in April, and they are ignoring the facts, warned the CEO of a leading independent financial advisory and fintech.

The April print saw monthly core US CPI gains slowing to a 0.3% pace from 0.4% in March. The headline rate slipped back to 3.4% from 3.5%.

“The latest data will fuel market optimism that the Fed will cut rates this year,” said Nigel Green of deVere Group.

“The markets are extremely keen to hang this hope on anything, it seems – and April’s CPI print will do just nicely for that.

“However, this could be a masterclass in wishful thinking and ignoring the reality of the situation.”

The deVere boss explained that super cautious Fed officials will need to see several consecutive months of evidence showing inflation – which is proving far stickier than had been hoped – is really heading back to the 2% target before they consider a pivot on monetary policy.

“As such, we still expect there’s a considerable risk that they will not feel comfortable about cutting rates before 2025,” said Green.

“Also, when a shift does occur, and rates are indeed lowered, there will likely be a pause in the subsequent meeting to assess how the policy adjustment is impacting the world’s largest economy.

“If officials observe that the rate cut contributes excessively to market enthusiasm and demand, exacerbating price pressures, we would then anticipate there to be an extended pause.”

That said, Green argued there’s reason to believe that stock markets will continue their high valuations for the rest of 2024.

On Monday he cited two different narratives to support his analysis.

“First, is the expectation of sustained economic growth. The recent upward revisions in global economic forecasts by institutions such as the IMF and Bloomberg serve as additional fuel for the optimism fire.

Resilience

“At the heart of the bullish sentiment pervading international markets lies the resilience of the US economy. Key indicators, including consumer spending, job creation, and corporate earnings, paint a picture of a nation on the path to continued growth. This robust performance serves as the backbone of confidence, instilling trust among investors in the stability and strength of the world’s largest economy.

“In parallel, signs of a rebound in China, the world’s second-largest economy, and Europe beginning to shine, further adds buoyancy to the global economic outlook.”

Green added that, “the second narrative supporting the expectation of a continued stock market rally revolves around the anticipation of interest rate cuts in response to a potential economic slowdown.

“Should this happen, and central banks cut rates in response, this would also be expected to bolster equities.”

On Tuesday, Federal Reserve chair Jay Powell said that the US central bank would have to be “patient and let restrictive policy do its work”, indicating that officials are in no rush to cut borrowing costs.

The deVere CEO concluded that, the markets’ hopes for rate cuts, “shouldn’t distract investors who should remain focused on the Fed officials’ tone, as well as continuing to focus on companies’ core fundamentals.”