The most aggressive interest rate hike cycle in forty years is coming to an end; the 2024 rate cut cycle may soon begin

The Federal Reserve’s current rate hike cycle has shown significant signs of slowing down, with the target federal funds rate maintained in the 5.25%-5.50% range, holding steady for three consecutive meetings since September and November this year. As inflationary pressures gradually ease, market expectations for rate cuts are heating up, and the end of rate hikes has become a market consensus. According to data from the CME FedWatch Tool, the Fed may start a rate cut cycle as early as early 2024, marking an important policy shift.

From Extreme Easing to Aggressive Tightening: Policy Turnaround

After the COVID-19 pandemic, the U.S. Federal Reserve adopted unprecedented measures to stabilize the economy, rapidly lowering the federal funds rate to near zero (0%-0.25%) and launching large-scale quantitative easing, with the Fed’s balance sheet expanding from about $4 trillion to over $8 trillion.

However, high inflation data forced the Fed to pivot. In March 2022, the Fed officially began raising rates, marking the end of the easing era. During the subsequent rate hike cycle, the Fed raised rates 11 times, totaling 525 bps, bringing the benchmark rate from near zero to the current 5.25%-5.50% range.

Between June and November 2022, the Fed raised rates four consecutive times by 75 bps, creating the longest series of large rate hikes in U.S. history. This aggressive stance reflected the Fed’s concern over persistent inflation. It wasn’t until December 2022 that the rate hikes slowed, with single increases dropping to 50 bps, and later easing further to 25 bps.

Rate Hikes Effective but Far from Achieving Goals, Inflation Fight Still Ongoing

The Fed’s tightening policy has achieved notable results. The U.S. Core Consumer Price Index (Core CPI) has fallen from 6.45% in March 2022 to 4.0% as of October 2023, a cumulative decline of 245 bps. Nonetheless, this still leaves a significant gap from the Fed’s 2% inflation target.

Powell has emphasized in multiple meetings that pausing rate hikes is to carefully assess policy effects, not a signal of policy turning. The Fed’s decision-makers want to reserve an observation window before confirming that inflation is steadily returning to target. Major institutions like Goldman Sachs believe the rate hike cycle is nearing its end, but rate cuts are not imminent; the Fed may need further confirmation of stable downward inflation trends.

Rate Cut Window Approaching, Market and Official Diverge

As the end of rate hikes approaches, market focus shifts to the next policy cycle. According to data from the CME derivatives market, investors expect the Fed to start cutting rates as early as March 2024, with the probability exceeding 50%. If this trend continues, the Fed could implement five rate cuts throughout the year, lowering the federal funds rate target to around 4.0%-4.25%.

Major Wall Street investment banks generally agree that a rate cut cycle will begin next year, expecting the Fed to start easing in the first quarter, with a total reduction of 100-125 bps for the year. Goldman Sachs further projects that in 2024, the Fed will cut rates by 87.5 bps to around 4.50%, and in 2025, another 112.5 bps to approximately 3.375%.

However, Powell’s speech last month cast cold water on these expectations, emphasizing that “it’s too early to predict when policy will ease,” and did not rule out further rate hikes. Vice Chair Williams and Board Member Daly have also recently signaled hawkish views, suggesting that the timing of rate cuts may be delayed compared to market expectations.

BlackRock has openly stated that market expectations for rate cuts are “overly optimistic,” believing the Fed will not start lowering rates until the second quarter at the earliest, and that the number of cuts will be fewer than the market generally anticipates. Global markets are expected to face greater volatility in 2024. Institutions like JPMorgan and Morgan Stanley also advocate for a more cautious and gradual approach to rate cuts than the market expects.

End of Rate Hikes Confirmed but Path to Rate Cuts Still Uncertain

The current market consensus is that the rate hike cycle has ended, and the Fed has completed the main work of this tightening cycle. However, there are still significant disagreements between official policymakers and market participants regarding the timing, pace, and magnitude of rate cuts. The Fed prefers to remain patient until inflation further stabilizes, while markets are eager for policy shifts to realize profit opportunities.

This tug-of-war will gradually clarify in the first half of 2024, with the ultimate timing of rate cuts depending on the progress of inflation data.