The “rate cut camp” got some bad news last week.
Both the Consumer Price Index (CPI) and the Producer Price Index (PPI) for February were reported hotter than expected. That follows hotter-than-expected inflation reports for January as well. And that news lessens the possibility that the Federal Reserve will begin lowering interest rates anytime soon.
Still, those who are trading Fed Funds futures continue to price in a 60% chance of a rate cut in June. They’re expecting at least three rate cuts in 2024.
What are they smoking?
Sticky Inflation
The Fed raised interest rates throughout last year in an effort to knock inflation down towards its 2% target rate. It is holding interest rates “higher for longer” with that same goal in mind. The CPI and PPI reports last week show that inflation is stickier than the Fed wants it to be.
That means… unless there’s a surprisingly large drop in the March inflation numbers, there’s almost no chance the Fed will start lowering rates in June. And, if we use agricultural commodity prices as a guide, then the March numbers are likely to be hotter than expected as well.
Look at this chart of the Invesco DB Agriculture Fund (DBA)…
DBA reflects price changes in agricultural commodities. We looked at it back in January when DBA had rallied 5% in two weeks, and it was bumping up against a long-term resistance line. We commented that DBA looked ready to blast even higher.
Indeed, that is what has happened.
Agricultural commodity prices are up 7% in the past seven weeks. They’re up 12% since the start of the year.
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A Disappointed Market
It seems quite improbable the Fed would be looking to cut interest rates when prices are ramping up this fast.
But what about the Fed Funds futures? They’re showing a 60% chance of a 25 basis point cut in June. And stock market traders seem to expect the Fed to hint at that possibility when it meets this week.
My guess is the market is setting up to be disappointed.
Remember, when we last looked at DBA back in January, the Fed Funds futures showed a 50% chance of a rate cut in March and an 80% chance of a cut in May. Those odds are now down to 0% for March and only 12% for May.
I suspect the odds of a June cut will fall sharply after the FOMC announcement on Wednesday.
Best regards and good trading,
Jeff Clark