The markets are unanimously expecting the FOMC at its 2-day meeting that begins today to leave its funds rate target range unchanged at 5.25%/5.50%. However, the markets are still on guard for one last rate hike this year.
Specifically, the markets are discounting the odds at 29% that the FOMC at its next meeting ending on November 1 will implement a +25 bp rate hike, and at +15% for that +25 bp rate hike at the following meeting that ends on December 13. Starting in 2024, the markets are not looking for any rate hikes, and are instead discounting roughly a -50 bp rate cut in 2024 from the current level and a further -50 bp rate cut in 2025.
The Fed today is expected to announce a so-called “hawkish pause,” meaning that the Fed will maintain a hawkish bias and will leave open the possibility of one last rate hike. Whether the Fed pulls the trigger on that last rate hike depends on the incoming economic data.
The Fed’s primary decision factor will be the inflation outlook. The FOMC will not rule out any further rate hikes until Fed members are virtually positive that the inflation rate is on its way down to the Fed’s target of 2%. However, it may take some time to see that actual inflation drop since the FOMC is currently projecting that the PCE deflator will end this year at +3.2% (core at +3.9%) and will dip slowly to +2.5% (2.6% core) by the end of 2024 and to 2.1% (2.2% core) by the end of 2025. The FOMC expects the PCE deflator to eventually average +2.0% over the long-run.
The PCE deflator has fallen sharply over the past year but remains significantly above target. The PCE deflator fell to a 2-1/3 year low of +3.0% y/y in June but then rose to +3.3% in July. The core PCE deflator fell to a 1-3/4 year low of +4.1% y/y in June but then rose slightly to +4.2% in July. The deflators are at least sharply below their 4-decade highs of +7.0% y/y (nominal) and +5.4% y/y (core) posted in the first half of 2022.
The Fed’s forecast that the PCE deflator will still be above-target at +2.5% by the end of 2024 is the reason why some economists doubt whether the Fed will actually cut interest rates in 2024. The Fed may only cut interest rates if forced to by an impending U.S. recession.
However, the current consensus is that the U.S. will avoid a recession and will see a soft landing in 2024. Bloomberg surveys show a consensus that U.S. GDP will dip to +0.9% (q/q annualized) in Q1-2024 and +0.5% in Q3-2024, but will not turn negative in any single quarter over the next two years. On a calendar year basis, the consensus is that U.S. GDP will ease to +0.9% in 2024 (from +2.0% in 2023) and will then recover to +1.9% in 2025.
If the U.S. economy avoids a recession in 2024 and if the PCE deflator remains above target in 2024, then market hopes for Fed rate cuts in 2024 are probably unrealistic. In that case, the funds rate could remain above 5% all during 2024. On the other hand, if a U.S. recession does occur in 2024, then inflation will likely fall fairly quickly and the Fed will likely be forced to respond with rate cuts.
On the date of publication, Rich Asplund did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
