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Inflation proving stickier than expected has dashed hopes for quick Fed rate cuts.

U.S. Federal Reserve Chairman Jerome Powell speaks during a news conference after the release of the Fed policy decision to keep interest rates unchanged, at the Federal Reserve in Washington, U.S, June 14, 2023. REUTERS/Kevin Lamarque

Inflation isn’t easing up as quickly as the Federal Reserve had hoped, leading investors to brace for a longer wait before the central bank considers cutting interest rates.

Two recent inflation reports have thrown a wrench into expectations of an imminent shift towards rate cuts by the Fed. The data suggests that inflation is proving to be more stubborn than anticipated, indicating that monetary policy may need to remain tighter for a longer period.

The first report, which focused on the consumer price index, revealed that inflation dropped by two-tenths of a percentage point to 3.1% for the year ending in January. While this marks a decrease, economists had anticipated a more significant drop. On a monthly basis, inflation actually rose to 0.3%, a level deemed too high by the Fed and equivalent to an annual inflation rate of 3.6%.

The wholesale inflation report also caught investors off guard. Inflation measured by the producer price index increased by 0.3% on a month-to-month basis, more than double the forecasted rate.

Adding to the concerns, the “core” PPI inflation, which excludes volatile food, energy, and trade services prices, surged by 0.6% in January alone, far exceeding economists’ predictions.

“These reports suggest that inflation is here to stay for a while. It’s like having an unwelcome guest who refuses to leave,” remarked Mark Hamrick, Bankrate’s senior economic analyst.

The recent data indicating a slower-than-expected decline in inflation are disappointing for investors who were anticipating rate cuts by the central bank in the first quarter of the year.

Since March 2022, the Fed has been increasing interest rates, pushing its target rate to a range of 5.25% to 5.50%, where it has remained since the bank paused its rate hikes in July.

Towards the end of 2023, investors were optimistic about the prospect of rate cuts in 2024, but this sentiment has shifted, with Fed officials exercising caution in projecting the timing of their moves.

Currently, the majority of investors expect the Fed to maintain rates following the March meeting of the Federal Open Market Committee. When the Fed convenes in May, investors anticipate a likelihood of rates remaining unchanged, with a pivot expected following the June meeting.

The Fed revises its multiyear projections for rate changes, inflation, GDP, and unemployment every other meeting. In its December projection, officials anticipated three rate cuts for 2024, whereas investors were expecting double that number at the time. The upcoming Fed projections after the March meeting will be closely watched.

Despite the tightening monetary policy, the robust labor market has provided some leeway for the Fed to keep interest rates higher for longer.

The economy has added jobs every month since December 2020, surpassing expectations. In January, the economy added 353,000 jobs, and the unemployment rate remained at a historically low 3.7%.

The strength of the job market amidst the central bank’s tightening has been a pleasant surprise, offering the Fed more room to exercise patience in its rate-cutting process.

However, the Fed faces a delicate balancing act, as it must navigate between stable prices and maximum employment. Keeping rates too high for an extended period risks damaging the labor market and potentially triggering a recession.

While many economists had predicted a recession by now, the U.S. economy has exceeded expectations, with positive GDP growth throughout last year. The Atlanta Fed’s “GDP Now” tracker forecasts strong GDP growth of 2.9% in the first quarter of 2024.

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