Fed holds rates steady as it implies three rate cuts in 2024

REAL ECONOMY BLOG | March 20, 2024

Authored by RSM US LLP

The Federal Reserve is looking to cut its policy rate three times this year, according to information inferred from the Summary of Economic Projections and policy statement released on Wednesday.

The cuts would reduce the policy rate by 75 basis points, from the current range between 5.25% and 5.5% to 4.5% and 4.75%, by the end of the year.

This is consistent with RSM’s policy forecast, which expects the first rate cut to take place in June, followed by two more 25 basis-point cuts this year, at the September and December meetings.

In the hour after the Fed released its statement, market participants were pricing in a 67% probability of a rate cut in June and three total rate cuts this year.

The primary takeaway from the Federal Open Market Committee’s policy statement and forecast is that the Federal Reserve, along with its counterparts at the Bank of Canada, Bank of England and European Central Bank, are likely to provide a near-synchronized set of rate cuts in the second half of this year and next.

Those cuts would bolster global growth and create the conditions for the new post-pandemic era international economy.

While the road back to price stability will remain bumpy, the Federal Reserve and other central banks are inclined to cut rates to offset the lagging impact of past hikes that have pushed monetary policy into restrictive terrain.

Federal Reserve Chairman Jerome Powell, in his remarks on Wednesday, implied that he thinks monetary policy is still restrictive; for this reason, we are sticking with our forecast of rate cuts starting in June.

The Summary of Economic Projections also implies that the Fed now expects two cuts next year, bringing the policy rate to a median of 3.9%, and then three more in 2026, to a median of 3.1%.

The long-run estimate of the federal funds rate stands at 2.6%, up from 2.5%, and the long-run inflation target remains at 2%. The long run neutral real interest rate stands at 0.4%, in line with estimates.

The risks around the Fed’s and RSM’s policy forecast is that 9 of the 19 FOMC participants think that rates will be cut two or fewer times this year, in contrast with the majority, or 10, participants who expect three cuts.

Should inflation ease in the housing sector in general and in the closely watched owner’s equivalent rent series, which our modeling of inflation expects, then the Fed will move to bolster growth by cutting rates.

Should that easing not happen, then the central bank can be expected to move more cautiously.

In addition, the SEP implied that the Fed expects growth this year to be 2.1%, the unemployment rate to increase to 4% and the personal consumption expenditures index to be 2.4%.

Growth next year and in 2026 is expected to be at 2%, which is above the long-term trend rate of 1.8%, while unemployment is expected to fluctuate between 4% and 4.1%. The core PCE rate is expected to arrive at 2.6% this year, then fall to 2.2% next year and to Fed’s target of 2% in 2026.

The PCE inflation forecast, which the Fed uses to make decisions, is expected to ease to 2.4% this year, 2.2% next year and back to the 2% target in 2026.

FOMC statement

The FOMC policy statement was largely a status quo affair. Here is a key part of the statement:

“The committee judges that the risks to achieving its employment and inflation goals are moving into better balance. The economic outlook is uncertain, and the committee remains highly attentive to inflation risks.”

From our vantage point, that risk opens the door just a bit further to the onset of what we expect to be a multiyear cycle of rate cutting.

In addition the statement said, “The committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.”

With the U.S. dollar moving higher against euro in the immediate aftermath and Treasury yields falling, the market response reaffirms the notion that this meeting maintained the status quo.

The takeaway

Monetary policy remains restrictive and the Federal Reserve is cautiously moving toward rate cuts this year starting in June.

The economy remains far more resilient than the Fed or anyone else expected just one year ago. As inflation continues to ease, the central bank expects to reduce the policy rate this year and next as the economy grows at a slightly above-trend rate and remains at full employment.

In addition, as interest rates fall, risk appetite will improve, which should ease pressures around the trillions in commercial real estate debt and corporate notes that will need to be refinanced over the next two years.

If the Fed and other central banks can create such conditions while addressing lingering financial issues created by the pandemic, then the economy will continue to expand.