The Federal Reserve is on the precipice of a major shift in policy as the economy, hiring and wages slow amid a backdrop of muted inflation.
As risks to the economy proliferate, the central bank is well-positioned to await the outcome of the G20 meeting later this month, which may determine future trade relations with China; the Fed will monitor the evolution of data, which will likely continue to show broader deceleration in the economy. In our estimation, the Fed will want to see a complete set of mid-year data before cutting interest rates.
In our estimation, the Fed will want to see a complete set of mid-year data before cutting interest rates.
Our model of the optimal policy rate indicates that the Federal Funds rate should be 1.8%, compared with the current Fed Funds effective rate of 2.27%. Consequently, we are confident that policy is now too tight, given the evolution of economic conditions. While market participants currently view both next week’s FOMC meeting and the July meeting as in play for a potential 25-basis-point rate cut, our view is that the committee will wait until September for the first rate cut, followed by another 25-basis-point cut in December.
That said, we anticipate a much more cautious Fed chair in next week’s post-meeting press conference. We think Chair Jerome Powell will place an emphasis on downside risks to the economic outlook, which will likely prove to be the main narrative to emerge from the June meeting.
The Fed’s dot plot, which presents a forward look at the path of the policy rate, will likely reflect a coming shift in the policy stance. While the median dot plot will indicate no change in the policy rate at the June meeting, we expect several dots to indicate possible rate cuts later this year.
Summary of Economic Projections
The Fed will probably revise lower its median growth forecast due to broader economic deceleration and the potential implementation of further tariffs on imported goods. The risks linked to trade policy will likely cause the central bank to reduce its estimate of long run growth to 1.8% from 1.9%. The Fed’s summary of economic projections will also likely shift to imply no rate hikes in 2019, 2020 and 2021.
The risks linked to trade policy will likely cause the central bank to reduce its estimate of long run growth to 1.8% from 1.9%. The Fed’s summary of economic projections will also likely shift to imply no rate hikes in 2019, 2020 and 2021.
We do not anticipate any major changes to the policy statement other than modest alteration to the language on inflation expectations linked to the decline in surveys and market-based measures.
Chair Powell faces a difficult balancing act in his press conference, given statements he made at the Chicago Fed conference on June 4 when he expressed an intent to act against downside risks to the economy.
Based on his recent policy comments we anticipate that St. Louis Fed President James Bullard will likely dissent in favor of a June rate cut.