The Federal Reserve (Fed) is responsible for setting U.S. monetary policy. It has two distinct mandates: full employment and stable prices (controlled inflation). While employment levels have remained healthy over the last few years, the other mandate of stable prices, as measured by inflation, has been elusive. Inflation increased rapidly in 2022, and the Fed increased the fed funds rate aggressively to slow economic activity and bring inflation back to the stated target rate of 2%-2.5%.

The latest Consumer Price Index (CPI), a common measurement of price stability, was 3.2%.¹ This level remains above the Fed’s target rate of 2%, but much improved over the 9.1% rate seen in June of 2022. Because of the substantial price volatility, and the effect of inflation on consumer pocketbooks, investors have been closely monitoring inflation trends and economic activity for clues to help determine what path the Fed will take with interest rates.

To combat inflation, the latest Fed tightening cycle has been one of the most aggressive in history. The chart below shows the Fed increased rates by 5.25%² over an 18-month period, which is the highest degree of increase since 1999.

In the fall of 2023, there was a significant pivot in Fed commentary that led investors to believe that the Fed would no longer be raising rates but might look to cut rates as inflation normalized. Over the prior three cycles, the average time between the Fed’s last rate hike and the first cut has been 10 months.² The last rate hike was in July 2023, so if historical averages hold, a cut would be right around the corner.   However, we believe this cycle may take longer between the last hike and the first cut.

On March 20, investors received an update on Fed policy via a Federal Open Market Committee (FOMC) meeting and nothing dramatically changed. Going into the meeting, expectations were for three fed cuts before year-end and the Fed commentary was in alignment with expectations. Three fed cuts would take rates to 4.60% from 5.25% by year-end. Longer term they are still projecting interest rates at 2.5%² (see chart below).

At the end of last year, the Fed indicated they were done with the tightening cycle (raising interest rates) and would transition to a less restrictive monetary policy (cutting interest rates) when data supports the transition. As a result, investor expectations were for as many as six interest rate cuts in 2024. As a result of stronger economic activity and persistently elevated inflation, expectations have now been reduced to three anticipated cuts.   

Investors focus on the path of the Fed because interest rates affect many areas of the economy. At Gradient Investments, we believe the Fed interest policy was a driver of the stock and bond markets in 2022 and 2023. Stocks, however, are rarely driven by only one factor. We believe the Fed actions may have been overblown as a driver in the short term, and in the long term, corporate earnings growth will have a much greater influence on stock market trends. It is our expectation that inflation is on the path to normalization, and Fed actions, while always important, will be less of a driver of asset performance in future years.   

1. February CPI
2. Blackrock: Student of the Market