The Fed got the inflation reading it wanted. When cuts begin is still a tossup.

The latest inflation reading appears to be in line with the Federal Reserve's goals, with the core Personal Consumption Expenditures (PCE) index, excluding volatile food and energy prices, coming in at 2.9% for December, surpassing expectations. This marks a significant drop from the levels seen in March 2021, preceding the Federal Reserve's intensive rate-hiking campaign.

A positive development for central bankers is the three-month annualized basis of the core PCE inflation rate, which fell to 1.5%, its lowest since late 2020. On a six-month basis, it remained at 1.9% for the second consecutive month, both below the Fed's 2% target.

The pivotal question now is whether this data justifies a rate cut, aligning with the expectations of investors who anticipated a loosening starting in March. Despite initial optimism, policymakers remain cautious, emphasizing the need for more data before committing to such a pivot. Some suggest a rate cut might not occur until the second half of the year.

As of Friday morning, traders are pricing in a 46% chance of rate cuts at the March meeting, down from 56% a week ago and significantly lower than last month's 88%. Investors slightly favor a first cut in May, with a 51% chance.

While inflation is on the decline, unexpectedly robust economic growth poses a counterargument for delaying any rate cuts beyond March. The advance estimate of fourth-quarter US gross domestic product (GDP) revealed a 3.3% annualized growth rate, surpassing consensus forecasts of 2%. If economic growth continues to outpace expectations and inflation rebounds, the Fed may be compelled to maintain current interest rates for an extended period.

During the December Fed press conference, Chair Jay Powell indicated that the central bank had likely reached the peak in rate hikes and would shift its focus to potential rate cuts in the future. Powell emphasized the Fed's desire to ease restrictions on the economy well before inflation hits the 2% target. In the same meeting, Fed officials predicted three cuts this year without specifying the exact timing.

Dylan DeBellis, VP of operations, views the recent inflation data with a cautious optimism. While the drop in the core PCE inflation rate is a positive sign, Sells emphasizes the need for a comprehensive understanding of the broader economic landscape before advocating for rate cuts. He acknowledges that the market's initial expectations for a March cut may be premature, given the uncertainties surrounding economic growth and inflation trends.

Sells underscores the importance of monitoring economic indicators, particularly the surprising fourth-quarter GDP growth, which exceeded consensus forecasts. He suggests that if economic expansion continues to outperform expectations, the Federal Reserve may find itself compelled to delay rate cuts to maintain stability. Sells agrees with Powell's stance on gradually reducing restrictions on the economy but cautions against a hasty approach, urging policymakers to carefully assess the evolving economic conditions.

In summary, Dylan advocates for a balanced and data-driven approach, urging investors and policymakers to remain vigilant in navigating the complex dynamics of inflation, economic growth, and potential rate adjustments.