What Fed’s rate cut delay means for US and the world

WASHINGTON - The US Federal Reserve and its vast global audience thought 2024 would be a rate-cut bonanza. But with price inflation proving much stickier than almost anyone predicted, those expectations are fading fast.

The Fed on June 12 held rates steady and

pencilled in just one rate cut for 2024

, reinforcing policymakers’ calls to keep borrowing costs high for longer to suppress inflation.

Traders now see just one or two rate cuts happening in 2024.

That is a big letdown from the roughly six they expected at the start of the year and the three that Fed officials pencilled in as recently as March. Some investors and economists say there is a chance of no cuts at all in 2024.

The delay in easing monetary policy – and keeping rates “higher for longer” – has big implications for the US economy. It is also reverberating around the world.

1. What’s keeping US inflation elevated?

When US inflation peaked above 7 per cent in 2022, it reflected a broad-based increase in the price of goods and services. But now, with inflation back below 3 per cent overall, price increases are being driven mainly by a persistent shortage of housing.

Commodity prices and car insurance premiums are also contributing to the stickiness keeping inflation above the Fed’s 2 per cent target.

Some also point to Fed chair Jerome Powell himself for prematurely telegraphing interest rate cuts, which ignited optimism in financial markets and fuelled economic activity.

2. What are the implications for the US of ‘higher for longer’ rates?

The Fed’s benchmark rate affects borrowing costs across the rate spectrum. It means that loans for home and car purchases will continue to be much more expensive than they were before the Fed started raising rates in 2022. 

Indeed, average mortgage rates in the US climbed past 7 per cent this week for the first time in 2024.

The cost of financing has hindered recent momentum in the housing market, as prospective buyers move to the sidelines until financing costs ease.

Also, inventory remains low because so many home owners do not want to give up the cheap mortgages they got when benchmark rates were near zero. That is helping to keep listing prices high.

3. How does Fed policy affect the rest of the world?

Despite the Fed’s stance to stay on hold, some of its global peers are moving forward with rate cuts anyway. Last week, the Bank of Canada led the Group of Seven in lowering borrowing costs, and the European Central Bank (ECB) followed suit.

If those institutions, along with the Bank of England (BOE) and Reserve Bank of Australia, move ahead with their own easing cycles, that risks driving down their currencies – raising import prices and undermining progress in getting inflation down.

But not easing could risk lost growth.

The ECB, for its part, all but ruled out a second rate cut in July, and some also question if such a move would be wise at the following meeting in September. The BOE pivot to rate cuts is likely to take longer, with traders pricing the first reduction in autumn.

Higher for longer rates keep the US dollar strong against other currencies because the prospect of persistently lofty US rates makes investing in US securities more appealing on a relative-value basis, causing the greenback to appreciate.

With every tick higher in the US dollar though, things get tougher for developing economies – especially for those that have US dollar-denominated debt that becomes more expensive to pay back as their home currency weakens.

Bank Indonesia had to raise rates in October and again in April after an extended bout of currency weakness.

The central bank had to intervene in currency markets as the rupiah weakened beyond 16,000 for the first time in four years. For countries from Malaysia to Vietnam, economists now expect fewer rate cuts. BLOOMBERG