Fed Pivots, Signals Rate Cuts Are Ahead

This week’s FOMC meeting brought an important pivot from the Fed, as they signaled rate cuts are ahead next year.  

The Fed’s change in tone follows a period of aggressive hikes to their benchmark Fed Funds Rate (the overnight borrowing rate for banks) to try to tame runaway inflation. The eleven hikes made between March 2022 and July 2023 were designed to slow the economy by making borrowing more expensive and lowering the demand for goods, thereby reducing pricing pressure and inflation.  

Just like they did at their September and November meetings, the Fed paused any further hikes at this week’s meeting, leaving the Fed Funds Rate at its current range of 5.25% to 5.5%. This decision was unanimous and also noteworthy because their tone was less hawkish than it had previously been. Hawks are policy makers who favor higher interest rates to keep inflation in check.

In fact, at his press conference following the meeting, Fed Chair Jerome Powell acknowledged the “very good news” that “inflation has eased from its highs.” Plus, the “dot plot” of Fed member forecasts for where policy rates will be in a year showed that 15 out of 19 members expect cuts between 50 and 100 basis points over the course of next year.

Powell also made two additional crucial comments during his press conference. The Fed’s target for annual inflation as measured by Core Personal Consumption Expenditures is 2%. Yet, Powell confirmed that Fed members won’t wait until inflation reaches 2% to start cutting the Fed Funds Rate, so they can account for lags in the data. For reference, Core PCE as of October is 3.5%, down from last year’s high of 5.6%. November’s data will be released on December 22.

Powell was also asked what level inflation would have to reach for the Fed to start cutting rates, but he would not commit to any specific percentage. This makes sense given there are many variables that will factor into their decision, including the strength of the economy and the labor market.

On that note, the unemployment rate is another factor we’ll have to monitor, given the Fed’s dual mandate of price stability and maximum employment. According to the Summary of Economic Projections that were also released yesterday, most Fed members don’t see the unemployment rate moving above 4.1%, so this will be a key level to watch. If the unemployment rate does rise this high, the Fed could decide to be more aggressive or move up the timing of rate cuts.

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By Shelly Williams @ MBS Highway