How are we thinking about the September FOMC meeting?
On Wednesday, the Fed cut rates by 50 basis points, while using its ‘dot plot’ to signal a more gradual pace of cuts going forward. Policymakers did not choose to end QT, underscoring that they will continue to allow bonds to roll off its balance sheet for now.
What do we think you need to know?
- We agree with the Fed’s base case for a soft landing. In the near term, however, we see more downside risks to growth versus upside risks to inflation. Chair Powell expects the economy to remain at ‘full employment’ going forward, which would support the Fed’s intention to cut rates only gradually in 2025-2026 after a further 50 basis points of cumulative rate cuts at the next two meetings. In reality, we think that the Fed’s focus on ‘risk management’ – paired with a murky employment picture – will likely lead the Fed to cut a bit more aggressively than we previously thought.
- As such, we lower our 2024 fed funds forecast to 4.375% (in-line with the Fed’s ‘dot plot’), while maintaining our forecast of 3.125% for 2025 (25 basis points below the Fed’s estimate). NFPs are flirting with recession, so we still see flat-to-wider spreads and the potential for more easing at the front end of the curve in the near term.
- Bigger picture, however, we continue to see a higher resting heartrate for inflation leading to a higher ‘neutral rate’ this cycle, which is why we remain more hawkish than the Fed or markets on longer- term rates. Said differently, we expect some compensation for bigger deficits, heightened geopolitics, a messy energy transition, and higher services inflation. To this end, we stick to our bond yield forecast of 4.0% over the longer term (market is currently around 3.6-3.7%). Key to our thinking is that Fed easing will likely contribute to easier financial conditions at a time when fiscal stimulus is booming and protectionism is on the rise. As such, we think that the ‘action’ this cycle will be focused on the pace of rate cuts at the front of the curve – whereas we actually expect more steepening at the long end.
- Despite recent declines in rates across the yield curve, our message remains that this is still not the time to over hedge, or to place big bets on duration. Current market pricing is not far off our forecasts, and we see two-sided risks to our base case for rates. As such, we would wait for a growth scare before aggressively locking in floating rate liabilities in the near term. At the same time, however, we also remain a bit more bearish on the potential for the 10- year to rally in response to weakness.
