Fed’s Conservative Inflation Projections Could Mean Two Rate Cuts
Despite a seemingly Hawkish stance, a closer look suggests the Fed’s conservative inflation estimates could lead to more rate cuts than anticipated.
- Markets & Economy
- Central Banks
- Monetary Policy
- Commentary
Key Points
What it is
We examine the Fed’s conservative inflation outlook, shedding light on the policymakers’ close decision on the necessity of one or two rate cuts this year.
Why it matters
Understanding the Fed’s inflation outlook and rate cut expectations is crucial as it directly impacts investment strategies and market stability.
Where it's going
Expectations for the Fed’s rate policy hinge on continuous monitoring of inflation data, which will determine if one or two rate cuts are warranted.
U.S. monetary policymakers’ views on the appropriate path for the federal funds rate — summarized in the so-called dot plot — are always closely scrutinized by investors. The median policymaker now favors only one cut for this year, compared to three cuts in the previous dot plot. While some observers saw this as a sign that the has turned more hawkish, we have a different interpretation. Let’s take a closer look.
First, let’s do some simple math. Only four policymakers thought it would be appropriate to keep rates unchanged this year. Among the remaining 15, a small majority (eight) viewed two cuts as appropriate, while the remaining seven preferred just one. This led to the median view of one cut, reached by a slim margin. And, as if to emphasize this point, the Chair highlighted that he can’t really distinguish between these two outcomes, seeing both as plausible. We heard this as the Chair minimizing the significance of the median view.
Chair Powell described FOMC participants’ inflation projections as “fairly conservative,” which we understood as him downplaying the magnitude of the upward revisions to the projections for this year and next. In this context, conservative means that the forecasts were too high, suggesting that they are especially subject to downside risks. Given that the outlook for rates is closely tied to that for inflation, we believe the median dot for this year is also too high, suggesting that are more likely than one this year.
We also see a reasonable chance that some of the projections were already somewhat stale. The Chair volunteered that most policymakers don’t update their projections to reflect data released during FOMC meetings. The data in this case was the consumer price index (CPI), which he called “certainly a better inflation report than almost anybody expected.”
So, to us, inflation remains the key data to watch. While characterizing the latest CPI report as “building confidence,” the Chair noted that “we’ll need to see more good data to bolster our confidence that inflation is moving sustainably toward two percent.” He called attention to the upcoming month-over-month changes in consumer prices over the second half of this year, pointing out that the upcoming 12-month changes might be exaggerated by the low inflation readings in the second half of last year. We’ll be watching the month-over-month changes closely.
The Federal Open Market Committee (FOMC) of the Federal Reserve holds eight regularly scheduled meetings a year to review economic and financial conditions and determine monetary policy. It sets the federal funds rate target, which is achieved through open market purchases by the Federal Reserve and has a broad impact on interest rates in the financial system and the economy. The committee consists of 12 members from regional reserve banks.
Main Point
Fed’s Inflation Outlook Signals Potential for Two Rate Cuts
The Federal Reserve’s cautious stance on inflation suggests two rate cuts may be on the horizon this year. Our analysis reveals the narrow split among policymakers and highlights the crucial economic data influencing this outlook.
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Antulio N. Bomfim
Head of Global Macro – Global Fixed Income
Antulio Bomfim, head of global macro for the global fixed income team, oversees interest rate strategy, systematic volatility, liquidity and monitoring of systemic risk globally. He is also responsible for the firm’s global liquidity management business.
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