The Federal Open Market Committee kept its federal funds policy rate between a range of 5.25% and 5.5% at its meeting Wednesday while signaling that it is moving toward easing its restrictive policy rate.
We expect that the FOMC will reduce the policy rate by 25 basis points at its September meeting and then do so again in December.
We expect that the FOMC will reduce the policy rate by 25 basis points at its September meeting and then do so again in December.
It is time to cut rates and one could hear Federal Reserve Chairman Jerome Powell walk right up to the line in his news conference afterward, when he stated that he would not pre-commit to a rate cut at the next meeting.
Just as important, Powell explicitly stated that “we are more confident that we are on a sustainable path down to 2%,” which is the Fed’s inflation target.
In addition, Powell noted the improvement in housing inflation and that the economy is not overheating, which are two key ingredients on the path to a policy pivot and lower interest rates.
While market pricing implies that investors have fully priced in cuts at both the September and December meetings, the probability of rate cuts is currently 62% in November and 70% in January, which in our assessment is a bit too aggressive.
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Despite that more aggressive view, our core baseline forecast anticipates a much more cautious Fed cutting rates by 25 basis points four times next year—at its March, June, September and December meetings—contingent on the evolution of the economy.
In addition, it is important to note that even as the Fed holds its rate at current levels, real rates rise as inflation growth eases.
The real federal funds rate has increased to 2.9% even as the 10-year yield has eased to 4.1%, which in our estimation is too high compared to the current growth path, a cooling labor market and inflation moving back toward target.
This overall slowing in the economy is one critical reason the Fed should not wait until the personal consumption expenditures index, the Fed’s preferred measure of inflation, reaches the 2% target.
The key change in the policy statement that supports our view is: “The Committee judges that the risks to achieving its employment and inflation goals continue to move into better balance over the past year.”
In our estimation, the Fed, noting its dual mandate, has moved into better balance and is not exclusively focused on price stability.
This improved balance strongly implies that the Fed is now prepared to reduce a policy rate this is too restrictive for an economy that has an inflation rate at 2.5% and is steadily moving toward the 2% target. We are confident that the Fed will reach its target next year.
The FOMC just as importantly maintained, “In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goal.”
Although the statement provided a soft affirmation of current investor pricing and market sentiment around a September rate cut, the upcoming Jackson Hole Economic Policy Symposium represents the next logical site to provide a stronger hint at the Fed’s upcoming policy pivot.
Between now and September, there will be much noise around the Fed’s potential pivot and the upcoming election.
In our estimation, the instrumental independence of the Federal Reserve strongly implies that the Fed will and should move to implement policy in the best interests of the economy regardless of the election.
