This is what will happen to the US economy if there are no rate cuts this year

This is what will happen to the US economy if there are no rate cuts this year

Federal Reserve officials have said for months they need to see more convincing data showing that inflation is on a sustainable path to 2% before they can feel comfortable cutting rates. Last month’s unexpectedly hot Consumer Price Index report was the opposite. That’s why Fed Chairman Powell conveyed on Tuesday that the central bank will not cut interest rates anytime soon.

“Recent data clearly does not give us greater confidence and instead suggests that it may take longer than expected to reach [2% inflation],” Powell said Tuesday in a panel discussion with Bank of Canada Governor Tiff Macklem . US stocks initially fell after signals that rates would remain higher for longer, and Treasury yields rose to new highs for the year before falling again.

Markets, businesses and the White House have been laser-focused on the timing and number of rate cuts this year, but the prospect appears to be fading. How will the US economy handle more months of high interest rates? Not as good as it has been so far, experts say.

Investors rely on cuts
When Fed officials initially made three rate cuts late last year, markets hit new highs. The expectation at the time was that the first of those cuts would come as early as March. Investors tend to choose lower rates because it reduces the cost of borrowing which in turn can help increase profits. It also means investors have more money to pour into the market.

Then, as progress on inflation began to stall leading up to last month’s policy meeting, investors pushed back their timeline to June for the start of cuts. But investors were delighted when officials kept their median forecast for three rate cuts this year at last month’s meeting, leading to several new records for major US indexes. However, the momentum is waning. After last week’s warmer-than-expected inflation data, the Dow, S&P 500 and Nasdaq Composite have each shed around 2% of their value.

Even with the recent selloff, stock market prices still reflect expectations the Fed will cut later this year, said Itay Goldstein, a professor of finance at the University of Pennsylvania’s Wharton School of Business. “There’s a risk there that if the Fed doesn’t cut rates, the market price will go down.”

That will have a spillover effect on the overall economy, he told CNN. That’s because a decline in the stock market can cause firms to delay investment or cut costs. For example, Tesla announced it was cutting 10% of its workforce as the electric vehicle maker’s stock has plummeted this year.

Market downturns can also make households “feel like they’re not rich,” he added, which can also lead them to resort to exits.

High probability of recession
Since the Fed kept interest rates steady last year after 11 hikes that took rates to their highest levels in more than two decades, higher for longer has been the central bank’s mantra.

But the longer the Fed leaves interest rates higher means more pain could be inflicted on households and businesses, Goldstein said.

While that hasn’t been the case so far — especially given the latest retail sales report, which showed consumers are continuing to spend despite inflation and the highest interest rates in two decades — high interest rates tend to cause people to save more money than invest or spend it, which slows the economy . That risk will increase if the Fed does not cut rates this year, he said.

Already, expectations that the Fed will keep rates higher have pushed US Treasury yields up significantly. For example, the 2-year Treasury yield briefly touched 5% after Powell’s statement on Tuesday. That drives mortgage rates higher.

Ultimately, higher rates for longer “will increase borrowing costs across the economy, which may have a negative impact on consumer spending, business investment and the housing market,” said Brian Rose, senior US economist at UBS Global Wealth Management.

But not everyone thinks the rift in the economy will widen if the Fed doesn’t cut rates this year. “We think the economy is strong enough that it doesn’t need cuts to avoid a recession,” said David Mericle, chief US economist at Goldman Sachs.