Will the new year bring on old thinking?

“Markets are heading into 2024 with a similar expectation as they had heading into 2023. That expectation is for the Fed to cut its federal funds rate. During 2023 this expectation was off, with the Fed raising rates more than expected by the market into late July. Markets were expecting the Fed to cut rates during 2023 because they were forecasting a recession during the second half of this year.

With due respect to market consensus, these were not CPM’s expectations for this year. We had expected rates to rise higher over a longer time over the course of 2023, based in part on our expectations of stronger economic performance without a recession in the current year.

Heading into 2024, the market consensus expectation is of one or more cuts in the federal funds rates, starting soon. This time these expectations have more credence than they did a year ago. This time around, inflation has shown that it is on a more consistent and sustained downward path. Also, the negative impact on economic growth of higher interest rates will be felt more fully during 2024 than it was during 2023.

While there is a higher probability of a federal fund rate cut during 2024 than there was in 2023, the market seems to have gotten ahead of itself in the pricing of these possible rate cuts. So said Fed chairman Jerome Powell on Friday 1 December. This also has been CPM’s opinion: That the market consensus was expecting more cuts sooner than was reasonable to anticipate. this hope is reflected in the prices of various assets, including the precious metals – particularly gold and silver. Markets see the projected slowdown in economic growth and inflation as reasons for the Fed to start cutting its rates.

The Fed has consistently said that it has more tolerance for a cooling in growth than it does for inflation.

Growth is expected to slow during 2024, but it is coming down from a strong level with a lot of good things still in place economically. Inflation too is expected to continue softening during 2024. That said, reducing inflation down to the Fed’s target rate from present levels is expected to be a lot more challenging than it was to bring inflation down from the highs seen in 2022. This struggle to reduce inflation is expected to be coupled with relatively healthy labor markets. Following the trouble in hiring labor post the pandemic, businesses and companies are not expected to lay off workers in large numbers unless there is a significant downturn in economic growth, which is not what is expected for 2024. Healthy labor markets are a double-edged sword, supporting both economic growth and inflation.

All of the above factors together are expected to make the Fed somewhat reluctant to cut rates early or aggressively in 2024. The Fed has managed so far to bring inflation down without tipping the economy into a recession. Balancing these two issues will become more challenging for the Fed in 2024. If the Fed eases policy too soon or too much it risks a revival in inflation. If it eases too late or too little, it risks a recession. The Fed is of course trying to cool the economy just sufficiently to bring inflation in line with its target, what is popularly referred to as a soft landing. While this situation is ideal, it is very difficult to accomplish. Even though a soft landing is unlikely to materialize, a shallow recession has a fairly high probability of materializing.

The markets think that the Fed is trying to sound more hawkish than it is likely to act in 2024. This is similar to the market sentiment in late 2022 and early 2023 when the market was confident that the central bank would pivot toward loosening policy during 2023. It may have been wishful thinking or just misplaced pessimistic economic expectations then. Despite the Fed’s actions in 2023, which were the opposite of loosening policy, the market continues to replay this belief now. In 2024 this belief may prove accurate, but whether or not that happens will depend on economic conditions as the year progresses. As always, the Fed will respond to economic realities and not to market wishes.

Market sentiment as measured by the CME Fed watch tool, at the time of writing this report, is pricing in the first cut in interest rates as early as March 2024 and is expecting rates to be down around 125 basis points by the end of 2024 compared to the current federal funds rate of 5.25% to 5.50%. A Bloomberg survey of around 70 analysts in November puts the median federal funds rate at 4.45% at the end of 2024, with a wide range spanning from a low of 2.75% to a high of 5.5%.

CPM Group’s own expectation is that there is a likelihood of a recession sometime in the second half of 2024 or in early 2025. There are not only macroeconomic reasons for such a recession to occur but also ongoing political risks which will continue to act as headwinds to economic growth and join the growth of negative macroeconomic factors. Collectively political and economic factors are expected to drive the next recession.

CPM Group expects that interest rates have most likely peaked and are likely to decline in 2024. The extent and timing of the decline depends on how the economy evolves.

While CPM Group remains positive on gold and silver prices in 2024, the recent optimism in the market based on expectation of lower rates may be overdone and could result in some profit-taking.”