Investors Are Convinced That the Fed Has Finished Raising Interest Rates. Why Isn't It a Done Deal?

The Federal Reserve's decision to halt interest rate hikes and potentially consider a cut seems imminent, given the subdued October consumer-price index reading this week. However, there is a degree of uncertainty, and the Federal Reserve, while preferring a wait-and-see approach, acknowledges the possibility of another rate hike under certain conditions, according to Matt Stucky, Chief Portfolio Strategist at Northwestern Mutual Wealth Management Company.

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Stucky outlines a scenario where a rate hike could occur, involving an acceleration in consumer spending or a reversal of the improvement in inflation. He emphasizes the Fed's commitment to curbing inflation, noting that investors may not fully grasp this determination. Fed officials are cautious not to let the resilience in the labor market and, consequently, the strength of the consumer, derail their efforts.

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Despite bringing the fed-funds rate from zero to the current range of 5% to 5.25% in a short period starting with hikes in March 2022, Stucky suggests that the Fed is willing to wait. However, he underscores that policymakers still prioritize restoring price stability as their primary objective.

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Concerning the accelerated stock-market rally, Stucky suggests that the Fed is likely to maintain a tight policy until sticky wage growth above 4% falls back toward 3%. He warns that this could lead to a recession, impacting corporate earnings, and advises caution.

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Market indicators, such as fed-funds futures traders, currently show no chance of a rate hike at the upcoming Fed meeting, contrasting with a 15% chance a week ago and a roughly one-in-three chance a month ago. Traders are pricing in a series of cuts in 2024, starting in the second quarter.

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Some economists, like Steven Ricchiuto of Mizuho Americas, argue that it is premature to declare the end of Fed rate hikes. They caution against market speculation, pointing to around 100 basis points in rate cuts priced into the market following the October CPI reading.

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Vanguard economists acknowledge a high bar for additional rate increases in the near term but still anticipate another quarter-point rise in the fed-funds rate before the Fed concludes. They adjust their forecast for the peak fed-funds rate to 5.5% to 5.75% from the previous range of 5.5% to 6%.

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The October CPI data appears to be a source of relief for Fed policymakers, with falling gasoline prices contributing to a flat monthly reading. Core inflation, excluding food and energy, rose by 0.1%, resulting in a 4% year-over-year October reading, down from 4.1% in September.

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The S&P 500 is trading at two-month highs, and the market seems poised to exit a correction that began in late July, indicating a positive trend. Despite the cautious sentiments expressed by some investors and economists, many believe that the bar is now quite high for another Fed rate hike, with some asserting that the trend in core CPI supports the view that the Fed is done, barring unforeseen circumstances.