Fed wants to sustainably reach inflation target: Economist

The Federal Reserve swiftly dashed hopes of early 2024 interest rate cuts on Wednesday with Chair Jerome Powell going so far to say that March cuts look increasingly unlikely. Wells Fargo Senior Economist Michael Pugliese explains that the Fed isn't pivoting to rate cuts just yet because officials wish to achieve their 2% inflation target "sustainably."

"Yesterday's meeting really didn't change anything in our base case outlook," Pugliese tells Yahoo Finance. "I do think by the time we get to May, though, they'll have gotten a few more PCE deflator prints, a few more CPI prints, and if those come in as expected, I think you'll start to hear the tone shift towards 'okay, we finally got that confidence that we're on the right path."

Click here to watch the full interview on the Yahoo Finance YouTube page or you can watch this full episode of Yahoo Finance Live here.

Editor's note: This article was written by Luke Carberry Mogan.

Video Transcript

SEANA SMITH: Fed Chair Jerome Powell pouring cold water on investors hopes of a March rate cut. And it's showing up in the numbers this morning, at least, when it comes to expectations. Only 37% of traders are pricing in that cut for March. Makes a lot of sense because that's down from 53% yesterday.

Now, this outlook from the Fed is not a huge surprise. If you've been listening on our show, the strategist that we've been talking to, here's what they have had to say about the potential timing of a rate cut.

DAVID DOYLE: I have a hard time seeing them going in March, which, I know some other folks are out there suggesting, will be the case. I suspect it could be one or two meetings following that.

LIZ ANN SONDERS: I think the mix of what we saw in the data, if anything, reinforced that view that maybe early March is a little too aggressive.

SAM STOVALL: It won't be in March, in our opinion. It'll be in the second quarter, possibly, at the June FOMC meeting.

MARK ZANDI: They'll probably be on the cautious side and just wait another few more weeks. And probably the first rate cut will be in May.

SEANA SMITH: All right. So let's talk about that timing of the first rate cut. When it will be and what the pace of the cuts could look like? We want to bring in Michael Pugliese. He's the senior economist with Wells Fargo.

Michael, it's great to talk to you here. So we heard from Jay Powell yesterday, basically, saying, do not expect, he did say. Not basically-- he said it that do not expect a rate cut coming in March. What do you think the timing looks like for that first rate cut and then beyond the pace of the cuts before year end?

MICHAEL PUGLIESE: Yeah. Well, thanks for having me, Seana. And I think that's exactly right. So going into the meeting that we had yesterday, our base case was the first rate cut would happen in May. That'd be 25 basis points. And we'd get another 100 basis points through the end of the year. So 125 cumulatively.

And what I heard yesterday, I think, really just reinforced that, which is, yes, there's been a lot of progress on the inflation side of things. Yes, the economy's remained resilient. But it's not just about getting back to 2% on inflation, whatever indicator you're looking at. But it's about sustaining it.

And I think that was really the message we heard from Powell, which is we're on the trajectory to 2%. But we want to know we can sustain it. And we want to have that confidence. And so to me, yesterday's meeting really didn't change anything in our base case outlook.

I do think by the time we get to May, though, they'll have gotten a few more PCE deflator prints, a few more CPI prints. And if those come in as expected, I think you'll start to hear the tone shift towards, OK, we, finally, got that confidence that we're on the right path.

BRAD SMITH: Yeah, certainly. We got a sense of that from even the first few minutes of the presser, even before they got to the Q&A saying, that they believe the policy rate is at its peak for this tightening cycle. And the economy, if it evolves broadly as expected, it's going to be appropriate to begin dialing back policy restraint at some point this year.

So you're saying, maybe by May, but then what does that do for us in terms of the rate or the pacing of some of those cuts, as well going forward in the future? And where would the Fed make sure that maybe they're not cutting too quickly in that instance as well?

MICHAEL PUGLIESE: Yeah. And the way I think about this is on the way down. I think the cuts will start a little more quickly. And then slow down. Similar on the way up. When the Fed was at zero and inflation was super high, they had to play catch up. And those initial hikes, they went 75. They're back-to-back. And then they started slowing the pace down, 75, 50, 25, 25, every other.

And it wouldn't surprise me if the Fed went relatively quickly in those first few cuts. So we've got four straight 25 basis point cuts starting at the main meeting. And that carries you through to September. And I think once you get to the fall, they'll probably start to slow down some, as they don't know exactly where the neutral rate is. Maybe it's 250. Maybe it's 350. Maybe it's somewhere in between.

But as they get closer and closer to that upper band of where neutral is on policy, I expect them to proceed more cautiously, where I think there's more consensus right now is 550-- 5 and a quarter there on Fed funds. That's restrictive. They're right now to bring inflation down. And I think once they knock that first 100 to 150 basis points off past that, the cuts are going to be a lot more slow and gradual.

SEANA SMITH: And Michael, it's interesting because this, of course, is an election year. And Nick Timiraos over at the journal had an interesting piece out this morning, just talking about the Fed policy heading into that critical 2024 election that we have in just a few months.

Talk to us just about your assessment of the impact. Do you think it will, at all, impact the Fed's decision, the fact that it is a lead up here to an election?

MICHAEL PUGLIESE: Yeah. I really don't think it will. I think the Fed is really focused on its dual mandate. And the dual mandate being one, they want to protect the strong labor market they have. There have been a lot of lessons over the past 10 or 20 years that once you have a weakening in the labor market, it can be hard to stop, and really hard to get back.

And then, of course, they're focused on the fight they've had for the past few years. And that's taken a lot of twists and turns. The pandemic hit, cut to zero QE, all the steps they took, very rapidly ratcheting up more than 500 basis points of tightening, QT.

And I think at this point, this really critical inflection point, as they're trying to walk that fine line, as I think you said a couple of minutes ago, Seana. That to me is the primary focus for them. And it's not to say, they're not thinking about the election. What's going to happen on the other side of it with the debt ceiling, and the 2017 tax cuts and tariffs, and all these different factors?

But I think the primary thing that's going to drive the bus, that's going to drive market pricing this year is, what are those labor market readings look like? And what does the inflation data tell us?