It has been ten months since the Federal Reserve last increased interest rates. This break in rate hikes comes after a 17-month period during which the central bank raised interest rates by a significant 5.00%. This aggressive campaign marked one of the fastest rate hikes in decades, but the focus is now shifting towards potential interest rate cuts as the central bank gears up for its next policy move.
Anticipated rate cuts have been on the horizon, with investors initially expecting the Federal Reserve to begin cutting interest rates in March 2024. However, March has come and gone without any interest rate adjustments. What could be holding the Federal Reserve back from making these cuts? The answer lies in inflation and employment data.
The Federal Reserve operates with two primary goals in mind: price stability and full employment. Price stability entails maintaining low and stable inflation rates, while full employment indicates economic conditions conducive to generating new jobs and keeping unemployment levels low. One of the tools the Federal Reserve wields to achieve these objectives is through interest rate adjustments. Rate hikes are typically used to combat inflation, while rate cuts are employed to stimulate the economy in times of rising unemployment.
Throughout the recent 17-month tightening cycle, the Federal Reserve concentrated on curbing inflation. However, as inflation subsided, the central bank's focus pivoted towards its employment target. Initial concerns regarding higher unemployment rates due to increased interest rates were mitigated by this year's data, prompting a reevaluation of priorities. While inflation proved to be higher than anticipated in the first quarter, the unemployment rate continued to hover below 4%, giving the Federal Reserve more leeway to address inflation concerns.
As the market observed a slowdown in inflation progress, the expected timing for the first rate cut was pushed back. Investor projections now point towards a single rate cut in 2024, a significant drop from the six anticipated cuts at the year's start (shown in Figure 1). The first rate cut is not anticipated until the fourth quarter. If the market's predictions hold true and the Federal Reserve refrains from cutting rates until December, a span of 17 months will have passed between the last hike and the inaugural cut.
Comparing this to historical patterns, the current 10-month pause is notably longer than the average duration of previous cycles. Looking back at past tightening cycles, the periods between the last rate hike and the first cut varied. Looking at Figure 2, these "pause periods" ranged from four months in 1989 to as lengthy as 18 months in 1997 and 2006, situating the current 10-month pause well within the historical context. While the current hiatus is longer than expected, historical trends suggest that it is not entirely unprecedented.
Figure 1 Source: CME, Federal Reserve via Brookstone. Data from March 2019 to May 2024.
Figure 2 Source: Federal Reserve via Brookstone. Data from February 1989 to May 2024.