The Federal Reserve is largely expected to begin cutting interest rates at its September meeting. Many economists believe that the Fed has finally tamed inflation and the all-clear signal is there to start the interest rate ‘normalization’ process. However, history tells us that the Fed needs to be cautious.
Inflation is the Federal Reserve’s worst enemy. Post-pandemic, trillions of dollars of fiscal and monetary stimulus combined with supply chain constraints pushed inflation, as measured by year-over-year CPI, to as high as 9.1% in June 2022. Since then, CPI has moderated significantly to its most recent reading of 2.9% in July 2024. While this is certainly significant progress, for the Fed to achieve its long-term target inflation rate of ~2%, we expect the last mile to be the most difficult and dangerous.
If the Federal Reserve begins cutting interest rates too soon, it risks inflation spiking back higher. If that should happen, it could force the Fed to reverse course and begin raising rates again. This happened in the 1980s when Paul Volcker was forced to raise rates to a peak of 20% in June 1981. On the other hand, if the Federal Reserve waits too long to cut interest rates, it risks pushing the economy into a recession.
As history shows us, inflation tends to come in waves. Looking back at various inflationary environments, we have seen similar patterns where inflation starts declining, then rises, falls and rises even higher. The current inflationary and now dis-inflationary (when the rate of inflation slows but remains positive,) environment we are experiencing appears no different than historical patterns. We have now entered the dis-inflationary phase where the Federal Reserve needs to be cautious about cutting rates too soon and risk pushing inflation back higher. History shows that this phase lasts around 10-20 months before inflation spikes back higher due to rate cuts.
U.S. CPI Year-over-Year
![U.S. CPI Year-over-Year](https://i0.wp.com/ancora.net/wp-content/uploads/Strategas-CPI-Waves.png?resize=640%2C366&ssl=1)
While many want the Federal Reserve to cut rates significantly (some have called for multiple 50 or even 75 basis point rate cuts,) they must be careful about cutting too much too soon. The Fed must have patience to ensure that inflation is in fact under control.