The FOMC’s normalisation cycle begins
50bps delivered and another 50bps seen by year end by the FOMC.
At the September meeting, the FOMC decided to cut by 50bps to begin their policy normalisation cycle. The Committee projects another 50bps of cuts to end-2024 (over two meetings), another 100bps of cuts in 2025, then a final 50bps in 2026, leaving the fed funds rate at 2.9%, which is also the Committee’s upwardly revised ‘longer run’ estimate of neutral.
The Committee’s statement and Chair Powell’s remarks in the press conference were worded carefully to highlight that the 50bp cut was not a signal of concern in the outlook, but rather a response to inflation slowing near target and the risks to achieving its employment and inflation goals now being “roughly in balance”.
The revised forecasts provided by FOMC members also speak to confidence in the economy. GDP growth is forecast to be 2.0%yr in 2024-2027, above their ‘longer run’ estimate of trend growth of 1.8%. The unemployment rate is consequently forecast to peak at 4.4% in 2024 then drift down to 4.2% through 2026 and 2027, where the unemployment rate is today. This implies little-to-no further deterioration in employment growth over the forecast period, in contrast to the marked deceleration in payrolls employment growth seen over the past two years – from 320k per month over the year to March 2023 to a 174k average over the 12 months to March 2024 (incorporating the BLS’ initial annual revision guidance) and now 116k in the three months to August. The inflation projections also point to an economy in robust shape over the outlook, with both headline and core inflation to trough at 2.0%yr not below.
It is worth emphasising however, while the ranges for the activity and price forecasts are narrow, the Committee’s views on the fed funds rate at end-2025, 2026 and 2027 are broad. Whereas the vast majority of the Committee see the fed funds rate only 25bps to 50bps below the current level by end-2024, the December projections for 2025 through 2027 are spread across a 150bp range. In 2027, the FOMC’s full range of estimates for the fed funds rate therefore stretches from 50bps below the their neutral estimate to 100bps above. To us, this speaks to considerable uncertainty over how the balance of risks will evolve and, as per Chair Powell’s remarks, a commitment to take “timely” action and “not to get behind” with policy. The FOMC regard the stance of policy as still materially above neutral and expect to return near it in time. How quickly they do so will be determined by incoming data and the perceived balance of risks.
To us, there is reason to be wary over a further deterioration in conditions and associated risks. We expect lower GDP growth in 2025 and 2026 of 1.8%yr and 1.7%yr versus the FOMC’s 2.0%yr. Westpac also expects a greater degree of weakness in the labour market, with the unemployment rate to rise to 4.7% in 2025 and hold there. Still, we also see inflation modestly above the FOMC’s 2.0%yr expectation in 2025 and 2026 as a result of supply-side pressures which are not easily resolved but, for the sake of inflation expectations, must be managed by the Committee. The 3.375% we have forecast for late-2025 speaks to these diverging risks and their persistence. The flow of data in coming months will be critical to assessing these uncertainties and their implications for the policy outlook.
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