FOMC meeting, June 11–12

Fed sees one rate cut ahead … just because

 

The Federal Open Market Committee (FOMC) voted unanimously to hold the federal funds rate at 5.25-5.50%. The statement was largely unchanged, while the dot plot now indicates only one rate cut this year, down from three in the March dot plot, and four rate cuts next year instead of three. While the overall growth picture was unchanged, inflation projections were upgraded to reflect higher-than-expected inflation in Q1.

 

We continue to believe a July onset of the easing cycle would have been optimal given easing inflation and softening labor market conditions, but a September onset is now more likely given policymakers’ backward-looking hawkish bias. We expect two 25 basis points (bps) rate cuts in 2024 and 125bps of easing in 2025.

 

1.       Wait-and-see posture. The FOMC policy statement was slightly tweaked to acknowledge the improvement in inflation data over the past two months. Officials substituted “a lack of further progress” for “modest further progress” toward the Fed’s 2% inflation goal. The sentence noting “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 percent” was preserved, essentially taking a July rate cut off the table. On the balance sheet front, the Fed will continue with a tapered quantitative tightening program with adjusted redemption caps on Treasury securities at $25b per month and on agency mortgage-backed securities at $35b.

 

2.       Hawkish dots. The new interest rate dot plot shifted higher as the rebound in inflation at the start of the year led Fed officials to lean toward delaying the onset of the easing cycle.

The median interest rate projection points to only 25bps of easing expected in 2024 and the fed funds rate at 5.1% in Q4 2024. However, the Committee is almost evenly split on the number of rate cuts expected this year, with eight policymakers favoring two 25bps cuts and seven members favoring only one 25bps cut while four policymakers expect no rate cuts. It is worth noting that 10 policymakers had penciled in three or more cuts at the March meeting compared to none in the new projections.
 

The Q4 2025 median projection was revised higher from 3.9% to 4.1%, indicating another 100bps of rate cuts next year, compared to 75bps in the March dot plot.
 

The estimate of the long-term neutral rate was also revised up from 2.6% to 2.8% as Fed officials increasingly acknowledge that rates will likely stabilize higher than in the decade pre-pandemic. Still, Fed Chair Jerome Powell made sure to stress that the neutral rate estimate was of little significance in telling how restrictive monetary policy was today.

 

3.       Summary of Economic Projections (SEP). While the overall growth picture was unchanged, inflation projections were upgraded to reflect higher-than-expected inflation in Q1.

The GDP outlook was mostly unchanged with real GDP seen at 2.1% year over year (y/y) in Q4 2024 and 2% in Q4 2025. Meanwhile, the unemployment rate was also unchanged in 2024 but is now expected to rise a little higher toward 4.2% in Q4 2025 and settle at 4.2% in the long run, instead of 4.1% previously.

 

Fed officials acknowledged the stronger inflation data at the start of the year, with core inflation projections revised up: core PCE inflation is expected at 2.8% y/y in Q4 2024 (versus 2.6% previously), while the 2025 projection was raised 0.1 percentage point (ppt) higher to 2.3% y/y. A majority of policymakers continues to see risks to the inflation outlook as tilted to the upside.  
 

4.       FOMC still searching for confidence. During the press conference, Fed Chair Powell failed to provide any forward guidance on policy and monetary policy transmission. He simply reiterated that the inflation data has so far not provided policymakers with greater confidence that inflation is moving sustainably toward 2% and that gaining such greater confidence would require seeing “more good inflation readings” and improvements in the “totality of the data.” In a break from prior communication, he shied away from any mechanical estimate of how many “good” readings would be required to build confidence.

 

The softer-than-expected May CPI report does not appear to have swayed the Committee’s lean toward fewer cuts. Fed Chair Powell acknowledged that the most recent inflation readings have been more favorable than earlier in the year but only noted that “there has been modest further progress” toward the 2% target. When asked if FOMC members had the chance to change their interest rate projections considering the latest CPI data, Fed Chair Powell stated that members have the ability to do so, but that “most people don’t.”

 

Fed Chair Powell reiterated that an unexpected deterioration in labor market conditions is a risk that could lead to interest rate cuts in the coming months. But he offered a positive assessment of the labor market over the past few months, pointing to increased labor supply, softer labor demand and fewer quits along with stronger job creation. He noted that “the overall picture is one of a strong and gradually cooling, gradually rebalancing labor market.”

 

When asked about the current policy stance, Fed Chair Powell noted that “the evidence is pretty clear that policy is restrictive” and “about right,” and that “the question of whether it's sufficiently restrictive is going to be one we know over time.” He also highlighted the two-sided risks of easing monetary policy too soon or too late while keeping a neutral tone and avoiding putting emphasis on one side of the Fed’s mandate.

 

Still, he didn’t provide any forward-looking rationale as to why the Fed would cut interest rates later this year if economic conditions remained largely unchanged (as per the SEP), or conversely why the Fed wouldn’t ease monetary policy today. 

The views reflected in this article are the views of the author(s) and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.