The Federal Open Market Committee kept its policy rate in a range between 5.25% and 5.5% at its meeting on Wednesday while signaling through its dot plot forecast of interest rates that the committee would support at least one 25 basis-point rate cut this year.
But the committee was split on the direction of rates. Seven members supported one cut, eight supported two and four supported no cuts. Overall, the forecast projects a 5.125% rate later this year. Taken at face value, the forecast implies that the FOMC supports only one rate cut this year, down from three in March.
While Federal Reserve Chairman Jerome Powell in his news conference attempted to convey that the dot plot simply moved a 25-basis point cut from this year into next year, that was a weak attempt at redirecting attention away from the obvious disagreement on the FOMC.
Our interpretation of the dot plot is that it looks confused given the May consumer price index inflation data published earlier Wednesday and the clear split within the committee on the direction of policy. There were no major changes to the policy statement.
In our estimation, it is still appropriate that the Fed cut rates twice this year by 25 basis points, in line with the eight FOMC members that support that move.
If the Fed cuts more slowly, the risk is that it will increase the risk of an unnecessary end to the business cycle. Powell noted that the committee thinks rates are indeed restrictive.
Should inflation continue to cool, it will be incumbent upon Fed speakers in general and Powell in particular to shape expectations accordingly to avoid unnecessary volatility in yields across the Treasury curve.
Read more of RSM’s insights on inflation, the economy and the middle market.
One gets the sense that the committee’s split on rates is a reflection of the uncertainty around inflation.
Based on the consumer price data, we think that the personal consumption expenditures index, which is closely watched by the Fed, will arrive near 0.12% on a month-over-month basis—we still need the May producer price index to make a final estimate—and result in a 2.7% annualized rate with a risk of 2.6%.
By September, the Fed will be in a much better place with respect to reducing its restrictive policy rate.
More important, the dot plot’s forecast for next year implies that the committee expects the policy rate to fall an additional 100 basis points, to between 4.0% and 4.25%, before reaching 3.125% in 2026.
In addition, the FOMC lifted its estimate of the terminal federal funds rate to 2.8% from 2.6% in March. This is in line with our estimate that the terminal rate will need to be lifted to 3% or higher.
The Summary of Economic Projections had only modest changes around the estimate of the PCE inflation forecast, which now stands at 2.6% compared with 2.4% in March, and in the core PCE, which now stands at 2.8% compared with 2.6% previously.
The SEP’s estimate of gross domestic product for this year remained at 2.1% and is 2% over the next two years, while the forecast for the unemployment rate forecast stands at 4% and is 4.2% next year and 4.1% in 2026.
