Federal Reserve Chair Jerome Powell isn’t ready to commit to a September interest rate cut, but it’s all but certain if good inflation continues to roll in.
As widely expected, the central bank kept the federal-funds rate target range unchanged at 5.25%-5.50% at its July meeting. A few observers had argued in favour of a July rate cut, and Powell acknowledged a serious discussion in the FOMC on the merits of such a move at the meeting. However, the judgment was overwhelmingly in favour of keeping rates unchanged.
The attention today centred on the Fed’s next steps. In the past, the central bank has used “forward guidance” as a tool in monetary policy, seeking to actively shape the market’s expectations of the future path of the federal-funds rate. For example, the Fed made it clear in the spring of 2022 that massive interest rate increases were on the way. This caused bond yields to rise, which effectively frontloaded the monetary policy tightening.
But since the middle of 2023, when the Fed ended its rate hiking, Powell and the Fed have been somewhat reticent on future policy decisions. Instead, the mantra has been “data dependence” and “meeting-by-meeting” decision-making. The Fed does issue quarterly projections of the federal-funds rate from FOMC members, but these are tentative forecasts and not commitments.
Markets See September Rate a Near Certainty
With that in mind, the Fed’s latest commentary is probably the clearest forthcoming signal that it’s likely to cut in September. This meeting’s official statement included new language that “the committee is attentive to the risk to both sides of its dual mandate,” whereas prior statements focused on “inflation risks.” Perhaps most importantly, markets now assign a near-100% probability of a rate cut in September, according to CME FedWatch. Powell made no attempt to gainsay such predictions.
Of course, market projections are contingent on a belief that fairly benign inflation data will continue to roll in. Powell said that further confidence that inflation is returning to the Fed’s 2% target will be needed before cutting rates, but that the “second quarter’s data has added to our confidence” and “more good data would further strengthen that confidence.”
FOMC projections from the June meeting called for one rate cut by year-end 2024 if the core PCE inflation rate reached 2.8% year over year in the fourth quarter of 2024. However, consensus projections are for core PCE inflation at 2.7% by then, and Morningstar’s forecast is 2.5%.
On the flip side, the labour market may be weakening faster than the Fed anticipated. The Fed had projected unemployment to reach 4.0% at the end of 2024, but it’s already at 4.1% as of June. All this calls for more than one rate cut by the end of 2024, meaning the Fed will most likely need to get started by September.
More Fed Rate Cuts To Follow
Markets are now projecting three cuts in 2024, taking the federal-funds rate down to 4.50%-4.75% by December. Markets expect a further four cuts in 2025, taking the rate down to 3.50%-3.75% by the end of the year. These expectations have fallen in recent months, converging closer to Morningstar’s forecast of 3.00%-3.25% for the end of 2025.
We expect the federal-funds rate target range to ultimately drop to 1.75%-2.00% by the end of 2026. Our views are driven by expectations that inflation will run slightly below the Fed’s 2% target in 2025 and 2026, while unemployment remains slightly elevated.
