Going into this year the market was expecting about 6 rate cuts and the Fed was predicting 3 cuts. After almost four months where are we? The Fed is still expecting 3 cuts while the market is around 2 cuts and some are even whispering about no cuts at all. A lot can change after a couple months huh?

So what changed? Rates were staying pretty level the first couple months of the year even after we had inflation go above expectations in January and February. After three consecutive higher readings of inflation though all bets were off and rates shot up to account for a readjustment of how many rate cuts there will be this year.

There is some good news when it comes to inflation though. As opposed to last year when inflation was broad now it is much more concentrated. The two big drivers of inflation are shelter (I’m sure that is shocking to hear right?) and…auto insurance. That might sound surprising at first but it does make sense when every new car has as much technology as a NASA space shuttle. Even a fender bender can be costly when replacing all of those sensors.

The million dollar question the Fed faces now is what is the risk and reward for cutting rates? Will keeping rates high impact car insurance for instance? That seems unlikely, it might stop some people buying new cars but it doesn’t change the cost to fix cars which is the real driver of the cost. Same goes for shelter. Does keeping rates high help cool the housing market? I’m not so sure about that, after all the reason why housing is high is because of the lack of housing that was built in the aftermath of the financial crisis. Does raising rates help increase the supply of housing? I would argue it’s the opposite since builders face increased costs to raise capital to build new properties. The risk is that keeping rates this high does have a chance to weaken other sectors of the economy which can lead to a recession.

This is the dilemma that the Fed faces. The Fed has clearly signaled that they are eager to cut rates but they can’t while inflation is projected to be over their 2% goal. The only hope, for rate cuts, is that unemployment goes over 4%. That would give them cover to signal a rate cut since it would show an underlining weakness in the economy. If not then it might be hard for the fed to cut rates much at all this year. Although as we’ve seen so far this year, things can change very quickly.

Recap:

• Inflation mainly driven by shelter and auto insurance
• Higher than expected inflation has made rate cuts less likely
• To get projected rate cuts unemployment would need to go above 4%