Inflation Subsides and Rate Cuts Loom: Navigating the Path to Economic Stability

Rate cuts are coming as inflation fears subside

With monetary policy set to get tighter, fiscal policy also becoming fractionally more restrictive, external demand looking weak and this student loan story set to hit quite hard, we are struggling to find a positive story that can offset these intensifying headwinds. As such, our narrative is one whereby recession has been delayed rather than averted.

Inflation looks set to continue slowing and we expect headline CPI to end the year below 3% with core inflation running close to 3.5%. The slowdown in housing costs is a key driver, but weakening corporate pricing power means we think even the Fed’s 'super core' measure of non-energy services excluding housing will be showing meaningful evidence of moderation.

We are also expecting the data discrepancies – for example, Gross Domestic Product pointing to growth yet Gross Domestic Income indicating recession, nonfarm payrolls rising yet household employment falling, ISM surveys pointing to falling output while official data points to rising output – to reconverge. Unfortunately, by the first quarter of 2024, we suspect it will be coalescing around the weaker trend. With inflation at or close to target by then, we argue this would justify the Fed moving policy to a more neutral setting, which means lower interest rates by quarter-end and through 2024.