Fed stays firm, consumers keep spending amid rising shipping costs from Red Sea tensions

Consumers have yet to stop spending

Last week brought end-of-year retail sales data from domestic consumers, which showed continued resilience in consumer spending amid the holiday season. Retail sales were up 5.60% over the course of 2023, which was over 1.5 times the rate of inflation. In December alone, retail sales rose by 0.60%, which was above economists’ expectations of 0.40% growth. The pleasant surprise from these figures reaffirms that consumers have yet to be scared off from spending and bolsters the argument that the economy may still be too strong for the Federal Open Market Committee (FOMC) to consider cutting rates.

Domestic markets remain selectively ignorant

Though their logic remains unclear, markets continue to blissfully ignore the words of Federal Reserve leaders and the messages of economic strength echoed by a slew of recent data releases. Though there have been some adjustments in recent weeks (two weeks ago, CME futures were showing projections of up to seven rate cuts this year), markets are still drastically overpredicting the number of rate cuts that the FOMC will enact this year. As of midday Friday, markets were pricing in an 85.00% probability of five or more rate cuts throughout 2024.

As the FOMC now enters their blackout period in advance of their January meeting, officials used the last week to once again reiterate that rate cuts will not happen in the immediate future. While Fed leaders remain firm that rate cuts will not arrive as soon or in such high quantities as the market may expect, they are vaguer on when exactly the first cut will come. Cleveland Fed President Loretta Mester offered a rebuttal to about 50.00% of the market in her remarks on Thursday when she said March “is probably too early” to consider a rate cut. Federal Reserve Governor Christopher Waller commented Tuesday that rate cuts are likely at some point this year, but that rates should be lowered “methodically and carefully,” another contrasting view to the five or six rate cuts markets are hoping for. Atlanta Federal Reserve President Raphael Bostic was the most direct in his remarks, commenting that he expects the FOMC to initiate their first rate cut “sometime in the third quarter this year.” Though he is not opposed to moving that up should inflation fall much faster than anticipated, Bostic’s worst-case scenario would be acting too soon and needing to go “back and forth” to combat additional inflation growth.

Language from Fed leaders continues to establish a clear divide between the FOMC’s plans for rates this year and what markets think the FOMC will do. This misalignment creates prime opportunities for hedging; if the Fed keeps to their word, organizations could lock in lower rates in an environment where interest rates remained elevated.

Shipping turmoil continues

After continued attacks on cargo ships in the Red Sea by Houthi militants, including one last Monday on a U.S.-owned ship, freight prices more than doubled over the past month. The Freightos Baltic Index (FBX) measured at $1,346.20 on December 22, and has now risen to $3,052.50. Chinese companies were hit particularly hard, with freight prices increasing almost three times over for shipping from China to the Mediterranean. More and more companies, (including Ikea, Maersk, and Nippon Yusen) decided to re-route their ships around the Cape of Good Hope, making freight ventures more time-consuming and expensive. That said, it has provided a financial boost for freight companies who are coming off a difficult year in 2023.

Though international companies are taking a hit, they have yet to pass these prices on to consumers, particularly in the United States. However, should the attacks continue through the winter, companies may need to start passing on the additional costs to their customers, which could have a larger impact on the domestic economy. It will also be key to continue to monitor the situation in the Red Sea and Suez Canal, as U.S. and U.K. forces began strikes against the Houthis in Yemen.

Looking ahead

This week will be another slower week for data releases, with the biggest news coming on Friday in the form of December PCE figures. The PCE data will provide another milestone in the Fed’s fight against inflation.