Inflation at 3% isn't the problem — it's the expectation that interest rates will soon fall, asset manager says
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- Markets are too optimistic about the prospect of rate cuts, SEI's James Solloway told MarketWatch.
- Inflation is still above the Fed's 2% target, while the labor market also remains strong.
- This means interest rates are likely to stay at higher levels for longer.
Markets are far too optimistic about the prospects of interest rate cuts — because inflation is still above the Federal Reserve's target, an asset manager told MarketWatch.
Inflation rose at the higher-than-expected pace of 3.4% in December compared with the same month in 2022, damping market expectations of imminent interest rate cuts.
However, 3% inflation "is not necessarily problematic," James Solloway, chief market strategist at Pennsylvania-based asset manager SEI, told MarketWatch on Thursday.
However, "what is problematic is market expectations, which seem to be pointing toward a return to the environment we had prior to Covid," Solloway said.
Lower interest rates boost demand for loans, spurring investment and spending, while higher rates have the opposite effect.
The Fed slashed benchmark interest rates to boost the US economy amid the Great Recession until they hit the range of 0% to 0.25% at the end of 2008. They remained low for the following decade, even with some gradual increases from 2015.
Interest rates were once again slashed to near-zero in March 2020 when the economy was hit by the pandemic. The Fed started hiking rates again two years later to cool surging inflation.
In December, the central bank signaled three interest rate cuts in 2024, exciting market participants as markets ended the year near record highs.
While inflation has fallen from a four-decade high in June 2022, it remains above the Fed's target 2% level. The economy is also performing strongly, with more jobs added in December than forecast.
Labor markets also remain tight across other major economies, which means wages are unlikely to fall to levels that will prompt interest cuts, Solloway wrote in a January 3 report.
This means "inflation is far from dead," and signaling rates are likely to stay higher, for longer.
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