Is Lower Inflation A Green Light For 2024 Interest Rate Cuts? Markets Are Ending The Year 'Surprised,' CIO Says

Personal Consumption Expenditures (PCE) index inflation dropped to its lowest point since March 2021 in November, reinforcing the market’s intensified expectations for multiple interest rate reductions in 2024.

With the Federal Reserve’s preferred measure of inflation declining more significantly than anticipated, economists are weighing in Friday on how this trend might influence the Federal Reserve’s strategy next year.

Chart: PCE Inflation Falls To 2.6%, Core PCE Eases To 3.2% In November

A Balancing Act Amid Surprising Inflation Dip: Chris Zaccarelli, chief investment officer for Independent Advisor Alliance, highlights the surprising dip in inflation.

Despite low unemployment rates, Zaccarelli said: "We entered 2023 worried about inflation … but we are ending surprised at how low inflation has come down." He remains cautious about the market's expectation of six rate cuts next year considering robust GDP growth and low unemployment levels. Zaccarelli said 2024 will pivot around whether inflation returns to the target sustainably or gets "stuck," potentially impacting equity markets significantly.

Encouraging Signs In Inflation Trends: Sam Millette, director of fixed income at Commonwealth Financial Network, noted the decline in PCE growth from 2.9% in October to 2.6% in November, with core PCE dropping to its lowest in over two years. This indicates a slowing of inflationary pressures, a positive sign for the Fed in its fight against inflation, he said.

Mixed Signals Amid Lower Inflation: Quincy Krosby, chief global strategist at LPL Financial, acknowledges the lower PCE inflation but points out resilient economic trends, including personal income and spending and durable goods. While the 3.2% annual increase is a win for the Fed, it also demands vigilance against potential price hikes driven by consumer confidence and corporate spending, he said.

Core PCE Signals Caution: Alex McGrath, chief investment officer at NorthEnd Private Wealth said the core PCE’s annual increase of 3.2% aligns with the Fed’s decision to pause rate hikes. Yet he points out that this figure still exceeds the 2% target, casting doubt on imminent rate cuts. The surge in durable goods orders further complicates the picture, potentially leading to an “Arthur Burns 2.0 moment” in 2024 if inflation isn't fully controlled, McGrath said,

Market Reactions: The release of the PCE inflation report on Friday was accompanied by a mixed bag of economic data. This included an upward revision in December’s Michigan Consumer Sentiment Index, contrasted sharply by a significant downturn in November home sales, which fell short of expectations.

The U.S. stock market continued to demonstrate resilience, with the SPDR S&P 500 ETF Trust SPY experiencing a slight uptick, rising by 0.3%.

The Nasdaq 100 Index, as represented by the Invesco QQQ Trust QQQ, also saw a modest increase of 0.2%. Notably, small-cap stocks outshined large-cap indices, with the iShares Russell 2000 ETF IWM rallying by 1.1%.

Sector-specific performance varied, with utilities and consumer staples leading the pack, recording gains of 1% and 0.8%, respectively.

In the bond market, Treasury yields saw a marginal rise, with the yield on the benchmark 10-year note inching up by 2 basis points to settle at 3.92%. In the commodities market, the SPDR Gold Trust GLD reported a 0.4% increase, with the price of gold pushing to $2,050/oz.

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Photo courtesy of the Federal Reserve.