- The Federal Reserve cut rates by 50bp in the September meeting, against our call for only a 25bp cut. The new policy rate target is 4.75-5.00%.
- The updated dots signal a total of 50bp of additional cuts in 2024, 4x25bp of cuts in 2025 and 2x25bp cuts in 2026. Relative to our call, the Fed signals a longer but more gradual rate cutting cycle.
- Powell downplayed recession risks despite the larger-than-expected cut, and most of the decline UST yields and weakening in USD FX reversed over the course of the press conference.
Markets were historically divided between 25bp and 50bp cuts going into the FOMC’s September decision. Powell accompanied the larger rate reduction with an overall positive assessment of the economy, ending the press conference saying: ‘I don’t see anything in the economy right now that suggests likelihood of a downturn is elevated.’
The larger move was motivated by a significant shift in the Fed’s risk assessment. 12 out of 18 participants saw risks to unemployment rate tilted to the upside (prev. 4 participants), and the median unemployment rate forecast was revised up through 2024-2026. While GDP forecasts were left mostly unchanged, 7 participants saw risks tilted to the downside also for growth (prev. 3). Inflation is seen stabilizing to 2% faster than previously expected with a balanced risk outlook.
Powell also mentioned that ‘it feels to me that neutral rate is probably significantly higher than it was pre-pandemic’. The median long-term ‘dot’ shifted to 2.9% (from 2.8%) with 7 participants now seeing the long-term rate at or above 3.25% (prev. 4). So, while the risk assessment and distribution of individual dots suggest that the Fed is open for faster rate cuts in the near-term if needed, rates could stabilize at a higher level longer-term.
Ahead of the meeting, some commentators voiced concerns over a larger cut potentially sparking rising recession fears in the markets. While most of the initial market reaction has already faded, Powell successfully maintained financial conditions on an easing trend. Yield curve steepened with 10y UST yield ending the session above its pre-announcement level. This reflects markets downplaying the probability of a recession, as faster rate cuts and consequently easing financial conditions are set to provide support for growth in 2025.
We expect the Fed to ultimately deliver a faster and shorter cutting cycle than the ‘dots’ suggest. We forecast 25bp cuts in every meeting until June and see the policy rate reaching 3.00-3.25% by end-2025. This is lower than the level implied by the dots (3.25-3.50%).
Markets are now pricing in a cumulative 70bp of additional cuts for the two remaining meetings of 2024, split roughly evenly between November and December. If labour market data continues weakening, we would expect markets to test the Fed’s call for only 25bp cuts in the remaining meetings. While we maintain our call unchanged, the bar for another 50bp move in November is now inarguably lower than before. Finally, the Fed maintained the pace of QT unchanged and Powell made it clear that the decisions regarding QT remain separate from rate decisions. We expect QT to run well into 2025.
