The Fed’s Path Forward
Authors & Contributors
How much and how soon can we expect rate cuts after the upcoming September FOMC meeting?
The Fed’s Rate Path
As central bankers departed the Jackson Hole Symposium at the end of August, Chair Powell made the message clear: “the time has come for policy to adjust.” With better news on inflation and a cooling labor market, the Federal Reserve (Fed) has enough confidence it will begin easing at its September 17 to 18 Federal Open Market Committee (FOMC) meeting. The question is no longer when will the Fed start to cut, but by how much and how fast.
Today’s chart shows the market’s expected path for the Fed’s policy rate implied by fed funds futures pricing. Pricing is now consistent with probability of a coin toss of either a 25 or 50 basis point cut by the FOMC at its meeting on September 17 to 18. Once the Fed’s ball starts rolling downhill, the funds rate is perceived to be at least 118 basis points lower by year-end. This seems to rest on concern that economic activity will slow considerably without monetary policy support and confidence that inflation will return to the Fed’s goal.
We think this expected rate descent is too steep. The labor market has indeed cooled, but from overheated levels. Recent data shows other sectors of the US economy, like the consumer, remain solid. Market pricing implies the Fed will deliver a jumbo cut of 50 basis points at one of the FOMC meetings between now and year-end. An outsized cut in the early innings of the easing cycle may present communication challenges as like-sized moves could be extrapolated further out. In framing its September action, the Summary of Economic Projections accompanying the September FOMC decision will be a key signaling tool. Any changes to the Fed’s ‘dot plot’ will be given close attention, which implied a gradual pace of cuts as shown on the chart in its last update in June.
An uncertain world argues in favor of a more measured approach to easing. The upcoming US presidential election on November 5 represents a large unknown with the outcome set to be a major force shaping the political economy over the next four years. Both candidates appear to favor increased trade protectionism, which would manifest itself as an adverse supply shock and inflationary risk over the medium-term.
We believe US economic activity will slow somewhat, but to a pace closer to potential. The headlines about consumer prices have been favorable for the past five months, but an assured return to the zone of price stability will take more time and may be uneven. Risks remain for inflation to increase as the Fed presses on the easing lever. We expect the Fed to start easing with a 25-basis-point cut at its September FOMC meeting and to proceed cautiously with like-sized quarter-point moves at each meeting through mid-2025, which is a more gradual path than markets currently anticipate.
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