By the end of 2023, market consensus anticipated a further decline in interest rates; however, this expectation has been postponed to a more distant future.

To better understand the fundamentals behind this perception, it is crucial to understand the pillars of the market. Among the various factors that influence interest rate fluctuations, inflation and government monetary policy stand out as elements of significant influence. Ultimately, we seek to understand why interest rates remain high and what is driving this trend, in order to adjust expectations for a possible anticipated decline.

On February 13, data related to the U.S. consumer price index (CPI) for the January 2024 period were released. As can be seen in Figure 1, the 3% increase for January 2024 exceeded the December 2023 indicators, which had been around 2%.

However, although the indicators continue to remain above the ideal, Figure 2 shows that the long-term target of 2% is being achieved in relation to the annual change in the Personal Consumption Expenditure (PCE) Price Index, which measures the price paid by individuals in the United States for goods and services. This index excludes food and energy prices, which tend to fluctuate more sharply, making it easier to monitor core inflation.

Although in 2023 inflation has shown a negative slope and has reached levels more in line with the historical norm, no rate readjustments have been announced. This is because the trend towards long-term inflation equal to 2% has not yet been reached. However, the bias shown in Figure 2 shows an inclination towards this target, increasing expectations of a reduction in the interest rate, as long as the trend towards 2% long-term inflation is maintained.

On the other hand, the tool used by the U.S. Federal Reserve (Fed) to counteract and manage the cyclical effects on inflation is the setting of the federal funds rate. Due to the inflation experienced, the governing committee of this institution has adjusted this rate on eleven occasions since March 2022, culminating its increases in July 2023, when it was in a range between 2.25% and 5.50%, a margin that has been maintained to date.

In addition, the Fed Chairman announced in January 2024 the latest decisions, which keep rates in the current ranges, but offer the possibility of reducing them in the future if economic indicators manage to demonstrate alignment with long-term inflation targets.

In conclusion, it is expected that rates are expected to remain high for a longer period than initially expected.

However, inflation is beginning to show a trend towards 2%, which, if it continues in the same direction, will be reached, thus providing indicators that will allow the Federal Reserve to reduce rates. While indicators point to a possible rate cut, the timing of this rate cut is uncertain, the timing of this adjustment remains an unknown, this transition is a matter of timing and monitoring of economic indicators.

Martina Jauregui

International Funds Analyst Fynsa AGF