The Federal Reserve is expected to begin a steady diet of rate cuts in 2024, but policy may still be restrictive by the end of next year.
Fed policymakers penciled in three rate cuts next year. That would bring down the fed funds rate from 5.25%-5.5% to 4.5%-4.75%. But markets are pricing in six quarter-point Fed rate cuts, possibly a seventh. Six cuts, or 150 basis points, would bring the fed funds rate to 3.75%-4%.
Those rate-cut expectations have spurred the big stock market rally at the end of 2023, with the 10-year Treasury yield tumbling from 5% in late October to well below 4% now.
But will Fed policy still be tight? That depends on the real federal funds rate, or how much its key rate exceeds inflation. The Fed's long-term estimate of a neutral rate — one that neither restricts growth nor boosts it — is 0.5 percentage point above inflation. The neutral rate is one that neither restricts growth nor boosts it.
Federal Reserve Inflation Gauge Cools
The Federal Reserve's favorite inflation gauge, the core PCE price index, cooled to an annual gain of 3.2% in November. Even better, the six-month annualized rate of change showed core inflation at 1.9%, below the Fed's long-term 2% target.
So if core PCE inflation cools to 2% by late 2024, a fed funds rate of 3.75%-4% would still be modestly restrictive, acting as a drag on the economy and inflation.
But it would be less restrictive than today. In Q3 2023, the real federal funds rate was between 3.25% and 3.5%.
The Federal Reserve also intends to continue its policy of quantitative tightening, letting its massive holdings of Treasuries and mortgage-backed assets dwindle over time.
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