US shares rose and bond yields fell sharply after the US Federal Reserve held interest rates steady and signalled that its policy tightening of the last two years is at an end.
The Fed also lowered its ‘dot plot’, signalling that it sees interest rate cuts in 2024.
A total of 17 of 19 Fed officials project that the policy rate will be lower by the end of 2024 than it is now -with the median projection showing the rate falling three-quarters of a percentage point from the current 5.25%-5.50% range.
The below report from the CBA’s Kristina Clifton (Senior Economist and Senior Currency Strategist) and Stephen Halmarick (Chief Economist -Head of Global Economic & Markets Research) explains the situation.
Key Points:
- The FOMC left the Funds rate unchanged at 5.25% to 5.50%,as widely expected.
- The post-meeting statement indicates that the FOMC no longer have a tightening bias and expect a rate cutting cycle the get underway in earnest in 2024. The dot plot shows an average of 75bp of interest rate cuts over 2024, and a further 100bp of cuts in 2025.
- The economic forecasts are consistent with a ‘soft landing’.
- We expect a short recession in the US, beginning in early 2024, and 150bp of rate cuts over 2024.
What happened?
As was widely expected by financial markets and economists, the FOMC left the Funds rate unchanged in the range of 5.25% to 5.50%.
The balance sheet continues to shrink. The policy decision was unanimous.
There were a few tweaks to the post meeting statement, watering down the previous tightening bias.
The FOMC noted that “recent indicators suggest that growth of economic activity has slowed from its strong pace in the third quarter”.
On inflation they said “inflation has eased over the past year but remains elevated”, compared to the previous assessment that “inflation remains elevated”.
In the postmeeting press conference Chair Powell noted that the FOMC “will tighten further if appropriate” but acknowledged that the dot plots don’t include any more rate hikes (see below). He also said that “monetary policy is well into restrictive territory” and will continue to weigh on the economy well into 2024.
Dot plot:
The new dot plot signals increased confidence in the inflation outlook. The FOMC assumes that it will cut the Funds rate by 75bp in 2024 and 100bp in 2025.
Previously 50bp of cuts were assumed for 2024 and 125bp for 2025. So the total amount of cuts is similar, but the timing has been moved forward.
The end point is also lower, at 3.6% at end 2025, compared to 3.9% previously, because the FOMC did not deliver the final hike assumed in the previous dot plot.
The assumption of the neutral rate was unchanged at 2.5%.
FOMC’s economic outlook:
The FOMC continue to expect a ‘soft landing’ for the US economy, with economic growth slowing but not contracting, the unemployment rate lifting modestly and inflation falling.
The 2023 GDP growth forecasts have been revised higher to 2.6%, from 2.1% in September. The large 4.9% saar outcome for Q3 23 GDP has lifted the 2023 forecast.
GDP growth for 2024 was revised down a fraction to 1.4% from 1.5% previously. The 2025 forecast remains at 1.8%.
The FOMC left their unemployment rate forecasts broadly unchanged, with the rate expected to lift modestly to 4.1% in 2024 and remain there in 2025.
The forecasts for the core PCE deflator have been revised lower for 2023, 2024 and 2025. The 2023 out turn is forecast to be 3.2% compared to 3.7% previously.
For 2024 the core PCE deflator is expected to fall to 2.4% in 2025, compared to 2.6% previously. And fall further to 2.0% in 2025.
Our view:
We continue to expect the US to experience a mild recession beginning in early 2024.
The Conference Board leading index and shrinking profits margins signal a recession.
Since the 1990s, the FOMC has typically begun a rate cutting cycle about nine months after the last rate hike. However given the resilience in the US economy we expect a slightly longer wait of 10 months, with the first rate cut on 2 May 2024 (the last hike was in July 2023).
The futures market is also currently pricing the first rate cut May 2024. We forecast 150bp of cuts in 2024 and a further 100bp in 2025, taking the Funds rate down to 3.0%.
The other policy arm of the FOMC is its balance sheet. We expect the FOMC to keep shrinking its balance sheet until April 2024, ie, just before it starts rate cuts.
However, the FOMC minutes from its July meeting suggest the balance sheet may continue to be runoff even if the Funds rate is being cut.
