The Federal Reserve initiated its rate-cutting cycle in September, aggressively cutting the benchmark interest rate by 50 basis points. The decision marked a significant shift in monetary policy as it was the first rate cut in the U.S. since 2020.
According to Wells Fargo, the size of the cut, along with comments from Fed Chair Jerome Powell, signaled some concern about the state or direction of the labor market rather than concern about inflation.
“Powell indicated during his press conference that the labor market was in a strong position and the Fed’s rate decision was aimed at keeping it there,” Wells Fargo strategists said in a recent note.
Federal Open Market Committee (FOMC) members expect unemployment to rise slightly to 4.4% in 2024 and 2025, while forecasting annual GDP growth of 2.0% over the same period.
According to Wells Fargo, this suggests that the “labor market is cooling, but not significantly.”
“Notably, FOMC members also expect inflation to continue to fall. We believe this baseline scenario sets the stage for rate cuts, but leaves the magnitude of them in question, particularly for the implied rate cuts in 2025,” they added.
The Fed’s updated forecasts differ from market expectations, however. According to the report, the market is expecting rate cuts of 125 basis points in 2024 and 2025, which is more aggressive than the Fed’s median forecast of 100 basis points of cuts in each year.
“With all but one FOMC participant expecting cuts of 100 basis points or less in 2024, the market could experience some disappointment,” the strategists continued.
“Market pricing would require at least one additional 50 basis point cut in 2024 rather than two 25 basis point cuts, which we believe is not supported by the current state of the labor market. Moreover, following Powell’s comments, we do not believe the Fed expects this outcome.”
Looking ahead, the strategists remain cautious about the market’s expectations for the Fed’s rate-cutting cycle, believing it to be “too optimistic.” They say cuts totaling 200 basis points by 2025 would likely require a significantly worse economic environment than their own or the Fed’s current forecasts.
“If the economy continues to move toward a gradual slowdown as expected, followed by a recovery in the second half of 2025, we believe the September cut will likely be the only 50 basis point rate cut we see in this cycle,” the note said.
In addition, Wells Fargo believes that inflation could potentially rise again by mid-2025, which could limit the Fed’s ability to implement all of the rate cuts it has forecast.
In their view, a more realistic scenario would be one in which there would be further cuts of 50 basis points in 2024 and 75 basis points in 2025.
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Reference;
Karaahmetovic, V. (2024) Takeaways from the start of a Fed rate-cutting cycle By Investing.com, Investing.com. Investing.com. Available at: https://www.investing.com/news/economy/takeaways-from-the-start-of-a-fed-ratecutting-cycle-3653574 (Accessed: 12 October 2024).
