Calling it an “appropriate recalibration” of the monetary policy stance, the US Federal Open Market Committee cut the Fed Funds rate by 50bps at the conclusion of its September 17-18 meeting. The decision marked a sharp pivot from the Fed’s stance at mid-year, when committee members saw higher inflation and a stronger labour market. Fed officials now see 20-30bps in lower inflation in the 2024-25 horizon, while about 20-40bps in higher unemployment rate during the same period. With forecasts for inflation heading toward 2% and unemployment toward 4.5%, the Fed sees the balance of risk tilting toward the labour market. Today’s policy easing, and a substantial change in median forecasts on inflation, unemployment, and Fed Funds rate, should be seen in that context.
In the post-meeting press conference, Chair Powell was emphatic in stressing that the upside risks to inflation have diminished and the downside risks to employment have increased. He cited data on payrolls growth, which has softened compared to earlier this year, as well as the weaker prints on nominal wage growth and jobs-to-workers gap. While conceding that economic growth is still robust, Chair Powell underscored the risk management approach to monetary policy, with the need to support the labour market going forward deemed as a higher order of priority.
We had expected the Fed going for a more cautious approach, but given today’s decision, have revised our forecasts for the Fed Funds rate considerably. We now see the Fed cutting by an additional 50bps this year and then follow it up with another 100bps in rate cuts in 1H25. There would be room for an additional 50bps in cuts in 2H25, in our view. That would take the Fed Funds rate down to 3% by the end of next year, in line with the neutral rate.
Risks to this forecast are a tad asymmetric. A sharper weakening of economic conditions could add another 50bps of rate cuts (Fed Funds rate at 2.5% by end-25). But a bigger risk, in our view, is that the economy keeps chugging along, labour market does not weaken much further, and inflation gets stuck at well above 2%. Regardless of the outcome of the Nov presidential elections, we expect no fiscal adjustment going forward, while monetary conditions are about to ease substantially. The risk is that a combination of easy fiscal and monetary policy begins to weigh in on the dollar, push up energy and financial asset prices, and eventually get in the way of the journey toward 2% inflation. Under this scenario, a prolonged policy pause could be in store from 2H25 onward, with even a possibility that markets begin to price in a reversal of the direction of interest rates.
All that is a good 6-9 months away, however. For the time being, we are set for a series of rate cuts.
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