Have The Markets Overpriced The Pace And Number Of Interest-Rate Cuts?

Weekly Economic Review: Jan. 22, 2024

Fast rate cut optimism appears to be slowly fading away.  The probability of a March rate cut is down to almost 50% chance from the 90% chance seen in the first and second week of January. The 2-year Treasury yield, which is more sensitive than longer maturities to rate changes, rose 25 basis points since the beginning of the last week, to 4.39%.  Also, the 10-year Treasury yield increased 19 basis points to 4.15%.  Why the sudden change in market sentiment?

Inflation.  We started the last week with contradicting inflation data from a hotter-than-expected CPI report followed by a cooler-than-forecast PPI.  While the PPI number was good news, the CPI figures indicate that inflation has not gone away.  The Fed may need to maintain higher rates to fight that threat.

Employment.  Last Wednesday the Labor Department reported that weekly initial applications for unemployment benefits unexpectedly plunged last week to the lowest level in more than a year, showing the resilience of the labor market. Also, continuing jobless claims went down for a third straight week in the week ending January 6, the lowest since October. These numbers indicate that the economy is still strong, and that businesses are hiring rather than laying off their workers.  Higher rates may be needed to combat “wage-push” inflation, and at the very least, the labor markets appear strong enough to eliminate the need for lower rates to stimulate hiring.    

Retail Sales.  On the same day, the Commerce Department reported a stronger-than-expected retail sales for December, mainly driven by clothing, general merchandise stores and e-commerce businesses.  This is the largest monthly gain since September, showing that the consumer remains resilient, thereby leading to solid economic growth.

Consumer Sentiment.  Last Friday, according to the University of Michigan’s monthly survey for January 2024, consumers are feeling more optimistic about the economy, their incomes, and the inflation outlook. Consumer confidence increased 13% in January to reach its highest level since July 2021.  Consumers expect inflation to be 2.9% over the next 12 months, which is driven by consumers’ experience with lower prices on goods and gas. Consumers are less concerned about recession and expect their incomes to be higher in the next 12 months.  The improved optimism on income is good news for businesses but could trigger more spending, thereby potentially slowing down the downward trend of inflation or even reigniting inflation pressures.

Housing.  Mortgage rates dropped after two weeks of increases to the lowest level since May.  The 30-year fixed rate loan was 6.6% per Freddie Mac announced in a statement Thursday. This is an encouraging development, but affordability remains a big issue for homebuyers. Housing starts dropped in December for the first time since August due to a drop in single-family home building, but building permits increased to a 1.5 million pace.  According to the National Association of Realtors, existing home sales dropped more than expected in December, the lowest since August 2010.  On an annual basis, existing home sales fell 18.7% to 4.07 million units, down from 5.03 million units in 2022 and the lowest level since 1995.  Bottom line, the latest economic data reveal an economy that is unexpectedly strong.  Consumers are optimistic and continue to spend, based in part on expectations of rising wages and continued employment.  The economy appears to be on a path to a soft landing or maybe no landing at all this year, without the need for further stimulus from the Fed.  If these trends continue, the Fed may well maintain its current high interest rates to battle inflation rather than reducing them to prevent a recession.

Compiled by:
Mark Yoon, CFA CPA
EVP & CFO of Commercial Bank of California

Thomas McCullough
EVP of Commercial Bank of California

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