Thursday’s inflation report could challenge the market outlook for big Fed rate cuts

Economists expect that inflation nudged higher in December, a trend that could call into question the market’s eager anticipation that the Federal Reserve will slash interest rates this year.

The consumer price index, a widely followed measure of the costs folks pay for a wide range of goods and services, is projected to have risen 0.2% in the final month of 2023, or 3.2% for the full year, according to Dow Jones.

At a time when the Fed is fighting inflation through tight monetary policy including elevated rates, news that prices are holding at high levels could be enough to disrupt already-fragile markets.

“The Fed did its policy pivot, and the data’s got to support that pivot,” said Jack McIntyre, portfolio manager at Brandywine Global Investment Management. “The market seems to have gotten excited that the Fed’s going to have to do more than what the Fed thinks in terms of rate cuts now. … The market got ahead of itself.”

There is certainly a wide gap between what the Fed has indicated in terms of rate cuts and what the market is expecting.

After months of insisting that easier monetary policy is still a ways off, central bank policymakers in December penciled in three quarter-percentage-point rate cuts by the end of 2024, effectively a policy pivot for this inflation-fighting era. Minutes from that meeting released last week did not indicate any discussion about a timetable for the reductions.

Markets hold a different view.

Traders in the fed funds futures market are pointing to a strong chance of an initial rate cut in March, to be followed by five more reductions through the year that would take the benchmark overnight borrowing rate down to a range of 3.75% to 4%, according to the CME Group’s FedWatch gauge.

If inflation data such as Thursday morning’s CPI release and Friday’s producer price index don’t show stronger inflation…