The Fed’s pivot has markets increasingly anticipating interest rate cuts to begin as early as 2024. These cuts are also expected to be much deeper than the Fed has forecast for next year.
As of Thursday, markets were projecting a roughly 80% chance of a first rate cut in March. According to the Federal Reserve’s CME monitoring tool. This is in line with the latest forecast from Goldman Sachs, which changed its outlook within a week Expectations of interest rate cuts from the fourth quarter of 2024 to March.
Goldman cited the Fed’s comment that inflation will fall faster than previously expected, along with recent inflation data that was cooler than expected.
“In light of the faster return to target (inflation), we now expect the FOMC to cut interest rates earlier and faster. We now expect three consecutive 25 basis point cuts in March, May and June to reset the interest rate from the level to be decided by the committee.” Federal Open Market Fund “We are likely to soon see a runoff,” David Merkel, chief U.S. economist at Goldman Sachs, wrote in a research note on Thursday.
The Federal Reserve on Wednesday released its latest Summary of Economic Expectations (SEP), including a “dot chart,” which outlines policymakers’ expectations about where interest rates could head in the future. The points showed that Fed officials expect interest rate cuts of 75 basis points next year, 25 basis points more than previous expectations.
The central bank expects core inflation to peak at 2.4% next year, lower than the September forecast of 2.6%.
However, investors took this news a step further. Before the Fed’s November meeting, markets had priced in just three rate cuts for next year, according to Bloomberg data. Now, after two Fed meetings left the benchmark interest rate unchanged and a more promising inflation outlook, investors are anticipating seven rate cuts by January 2025.
However, not all economists agree with aggressive pricing moves in markets.
EY chief economist Greg Daco has warned that just because there is a soft landing on the horizon, does not mean the US economy is in the clear.
Cost fatigue, caused by consumers continuing to pay more for everything than they did before the pandemic, may still impact how Americans spend going forward, he told Yahoo Finance Live on Thursday.
“They’re becoming a little more cautious about the number of goods and the number of services that they buy,” Daco said. “This will be the main story as we go into 2024. The main backdrop, the main anchor for a soft landing is a labor market that is not cutting spending. So far we haven’t seen the kind of reduction that precedes a recession. Will this continue?”
Daco noted that the Fed’s admission that it was closer to implementing cuts rather than raising interest rates again was “very important,” but it doesn’t fully account for how market expectations have moved.
“We have to be a little bit careful about the market’s pricing of interest rate cuts,” Daco said. “The Fed is not going to be in a rush to cut interest rates very quickly, unless there is a recession…so the euphoria about this soft landing and this environment where we won’t see any slowdown is probably overblown.”
“The Fed is not going to cut interest rates too quickly.”
Other economists agree with Daco. Wells Fargo, Morgan Stanley and Deutsche Bank still expect interest rate cuts to begin in June.
Wells Fargo’s team of economists sees June as the starting point for cuts because they believe the central bank will need to keep interest rates high amid “strong employment growth and high inflation.” But ultimately they see the Fed’s restrictive stance paving the way for cuts.
“We expect lackluster economic growth, a weak jobs market, and continued deceleration in inflation to prompt the Federal Reserve to begin lowering the federal funds rate,” the team wrote in a research note on Thursday.
The key to Wells Fargo’s call is how deep the economic slowdown is. If a recession occurs, Wells Fargo expects cuts of 225 basis points by the first quarter of 2025, about 50 basis points more than current market expectations. If that complete slowdown doesn’t happen, Wells Fargo sees the cuts happening at a “much slower pace.”
Josh Schaeffer is a reporter for Yahoo Finance.
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