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U.S. consumer prices ticked higher in February, raising questions about the Fed’s timeline for a potential interest rate cut in June. Alexandra Gorewicz, Vice President and Director for Active Fixed Income Portfolio Management at TD Asset Management, discusses the outlook for rates and the implications for markets.
Transcript
Greg Bonnell – Well, another piece of the US inflation puzzle has been revealed. The latest reading of the Consumer Price Index showed inflation remains sticky in February, rising 0.4% for the month and 3.2% from a year earlier. For a look at what this means for interest rates, the bond market, we’re joined now by Alexandra Gorewicz, Vice President and Director for Active Fixed Income Portfolio Management at TD Asset Management. Alex, always great to have you on the program.
Alexandra Gorewicz – Thanks, Greg. Great to be here.
Greg Bonnell – So we’ve got a fresh read right now on US inflation– two consecutive months now of stronger-than-expected readings. The equity market seems to be brushing off. What does that actually mean for the Fed in interest rates?
Alexandra Gorewicz – Well, I’m not sure that it’s a game changer. This CPI print had something for everyone. Yes, it was a little bit firmer than expectations. But actually, the 0.4 core reading for month-over-month inflation was unrounded 0.35. So it was actually somewhere between what was expected versus last month’s month-over-month reading.
On a year-on-year basis, yes, the print came in a little bit firmer but still showing deceleration from prior month. So, again, something for everyone in terms of takeaways whether you’re looking at headline or core.
Greg Bonnell – Regardless, you can believe what you want out of this number kind of thing.
Alexandra Gorewicz – Absolutely.
Greg Bonnell – Of course, the Fed is going to take it into their next meeting with them. And everyone wants to know– there’s not an expectation that we’re going to get that cut at the next meeting. But reading the tea leaves, the market thinks, perhaps June. Is June still on our radar, given the kind of data we’ve been getting out of the States?
Alexandra Gorewicz – So we talk a lot about CPI, because that’s probably most relevant to most people. It’s most quoted in the media but also highly tied to social benefits packages, a lot of wage benefits. So most people look at CPI– the Fed really cares about PCE. And when you look at PCE, it’s substantially lower than CPI.
This print on CPI has some pass-through effects in terms of what it means for the upcoming PC print which the Fed will not have come next week’s meeting. That’s important. But for PCE, the expectation is that maybe it’ll come in around 0.3% month-over-month, which would actually suggest that there’s still maybe a little bit of stickiness of what we saw in PCE from January, but not a lot to actually change the Fed’s equation if they, previous to this print, were intending to cut in June. After this, they’ll probably still intend to cut in June.
Greg Bonnell – So we’ve got a bit of stickiness there, we have a resilient labor market south of the border, a resilient economy. What are the signs in the economy right now in the States that actually have people believing, oh, at some point they’re going to come back? And, perhaps, even in June from these restrictive levels.I just always think if the economy can perform this well with interest rates at this level, do interest rates– do you need to be in a rush to come back down?
Alexandra Gorewicz – Yeah, that’s a great question. But taking it back to inflation, think about where CPI or PCE was when the Fed last hiked interest rates. And both measures are now lower than last summer.And if that’s the case, what that means is the Fed, which has been at 5.5% for the policy rate, has actually enabled its policy settings to tighten as inflation has continued to come down, even if it’s come down at a slower pace than what everybody has wanted.
And so what the Fed is probably most worried about here is, as time passes, even if infla– sorry– even if inflation stops at current level, their policy settings are tighter, and all this resilient economic data– the dynamics that we’re seeing around the labor market and some of the growth that has come through in the first quarter– they don’t want to throw cold water on that. They don’t want to be the reason why the economy slows down a lot, and so they’re really relying on the fact that their policy settings, by just standing still, have gotten tighter. And that gives them cover to still cut.
Greg Bonnell – When we do get the first cut, and if it does come in June, for argument’s sake, how many more cuts would you expect on the other side of that, and what kind of reaction would you expect in the bond market from all of that?
Alexandra Gorewicz – So coming into this year, the bond market was really ecstatic about the idea that the Fed would deliver more than the three rate cuts it had signaled it would deliver this year back at its December meeting. Now, next week, we will get updated economic projections from the Fed, and that includes an updated dot plot. We’ll see if some of the strength in the economic data, whether it’s inflation or growth that has come in year-to-date, changes the equation for how many rate cuts they’re intending to deliver.
But right now, based on the current dot plot of showing three rate cuts in ’24, the market is very much aligned with the Fed. And what that means is once the Fed starts cutting, they won’t be cutting at every single meeting. And this is something that they’ve clarified in their communication even as the data has come out. And even in the absence of an updated dot plot, they want to be slow about the easing process, particularly because the economy has been so resilient.
Greg Bonnell – Now the last time we heard from our central bank, the Bank of Canada, I think was the first question was about commercial real estate and what it could mean for our central bank. And I think the answer was, well, it’s not as big of an issue here in Canada as it is south of the border. This is my way of backing into– a commercial real estate question about the United States. Is the Fed watching? Is this a vulnerability for the economy, a vulnerability for their glide path, I guess, through the rest of the year?
Alexandra Gorewicz – So the way that CRE, or Commercial Real Estate exposure, could actually derail the Fed is actually more through the banking system. We know that the Fed has a dual mandate, maximum employment, and price stability. But actually, underlying its entire mandate is financial stability, which means it needs a sound banking system. Now it just so happens that a lot of regional banks, as particularly some of the key regional banks, have greater exposure to commercial real estate than, let’s say, some of the systemically important banks– some of the largest banks in the US.
And what this means for the Fed– which cares about again the entire banking system– is that should any kind of CRE stresses threaten the liquidity or the capital buffers of some of these larger regional banks, it could result in the Fed having to quickly react the way that it did in March and April of last year.
But it has other policy tools to be able to do that. Whether it’s through balance sheet reduction, whether it’s through the bank term funding program– which, yes, expires but doesn’t mean it can’t come back should it need to. So there are other mechanisms that the Fed can use. It doesn’t have to rely necessarily on lowering interest rates to address any kind of CRE problems that might still be lingering.
Greg Bonnell – Well, I’ve got about a minute left with you, Alex. I do want to ask you about our central bank now, the Bank of Canada. Anything else you’ve been seeing in the data recently on this side of the border that would suggest a different timeline for cuts from the BOC?
Alexandra Gorewicz – Not necessarily a different timeline. I think it’s still reasonable to expect with how inflation has continued to decelerate here at home that the Bank of Canada could be in a position to cut in June, similar to the Fed. And, again, similar to the Fed– although the Bank of Canada has been very explicit in not providing forward guidance on its forward guidance– the Bank of Canada should be assumed would be similar to the Fed in that they won’t want to cut interest rates quickly, despite the fact that our economy is much weaker than down south.
However, what could derail things would be housing. And we know that there are structural problems there, problems that the Bank of Canada cannot address through its policy settings. However, if some level of speculation comes through the housing side and house prices start to rise quite a bit, it’s possible it will delay the Bank of Canada’s easing cycle.
Greg Bonnell – Always great to get your insights, Alex. Thanks so much for joining us.
Alexandra Gorewicz – Thanks, Greg.
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