With a 25-basis-point cut in the federal funds rate widely expected at the Federal Open Market Committee meeting Tuesday and Wednesday, economists are pondering what happens after that while they eagerly await the release of the Summary of Economic Projections. Although some have kept a chance of a larger cut in play.
"Bond markets have fully priced in something like a hard landing scenario with 10 rate cuts over the next year, or one at every Fed meeting," noted Byron Anderson, head of fixed income at Laffer Tengler Investments. "I don't think it matters what the Fed says at this meeting, bond markets are going to be disappointed with the message and the Treasury rally will continue."
The markets expect a worse economic outcome than does the Fed, he said, "so the only remedy will be decent data and proof of the soft-landing."
Watch Marvin Loh, senior macro strategist at State Street Global Markets,
With wages rising, Interactive Brokers Chief Strategist Steve Sosnick said, "It is extraordinarily hard to make the case that the labor market is collapsing." The gain in wages "also makes it harder to make the case that prices are firmly under control."
And given the Fed's reluctance to "surprise markets or take actions that could be perceived as overtly political," he said, "we find it hard to believe that anything other than 25 bp is the likely outcome for the upcoming FOMC meeting."
But a half-point cut "would get the Fed back into the driver's seat," said Jan Szilagyi, CEO and co-founder of Toggle AI. "The Fed is behind the curve. Again."
A larger reduction this month would help the Fed "catch up," he said, as "many leading macro indicators are starting to suggest that a more aggressive easing will be necessary."
The rate at which the unemployment rate has risen "is particularly noteworthy," Szilagyi said, "because the pace of change (how fast the unemployment is rising) has been a pretty decent indicator of how likely the economy is to dip into a recession. No alarm bells yet but let's just say it's not all blue skies anymore."
Don't expect the Fed to ease aggressively, Fitch Ratings said in a Global Economic Outlook report.
"The long-awaited Fed easing cycle is upon us, but the FOMC will be cautious after the inflation challenges of the past few years," said Fitch Chief Economist Brian Coulton. "The pace of rate cuts will be gentle and monetary easing won't do much to boost growth next year."
Services inflation remains "too high to be consistent with inflation returning to target on a sustained basis," the Fitch report said. Rates will remain restrictive in 2025.
The market priced in aggressive cuts in the near future, said Subadra Rajappa, Societe Generale head of U.S. rates strategy. She expects a quarter-point cut at this meeting, "as a soft-landing scenario remains our base case."
Still a half-point move "is not out of the question if the committee feels it is necessary to front-load rate cuts," Rajappa said.
The SEP "will be closely scrutinized for clues to the likely pace of rate cuts," she said. The previous dot plot — with one cut this year followed by four in 2025 and again in 2026 — a "gradual pace of one cut per quarter is in line with our expectations."
Rajappa expects the new SEP will offer "at least one more 25 basis point cut this year and next, bringing the end of 2025 projection [for rates] down from 4.1% to 3.6%."
Dovish members of the panel could "skew the distribution of fed funds dots for 2025 to the downside," she added.
As for unemployment, the yearend projection is likely to be upped two ticks to 4.2%, Rajappa said, "reflecting the increase in unemployment but demonstrating the Fed does not seek any further deterioration in the labor market."
Inflation expectations may be reduced, she said, "paving the way for more cuts in the years ahead."
A 25-basis-point reduction and lowered rate projections for the future are expected by Ryan Swift, U.S. bond strategist at BCA Research. But "with the market priced for 113 bps of easing between now and the end of the year and only three FOMC meetings during that timeframe, we still see value in our short January 2025 fed funds futures trade."
With additional rate cut projections expected in the updated SEP, "the magnitude of that downward revision will send an important signal to the financial markets," Swift said. "A small downward revision could be perceived as overly hawkish, causing the Treasury curve to flatten and risk assets to sell off. Conversely, a large downward revision, to say a 200-bps-per-year pace or more, would likely lead to curve steepening and a rally in risk assets."
Chris Low, chief economist at FHN Financial, expects the Fed to pencil in three cuts this year.
But Fed Chair Jerome "Powell's press conference will add color to the SEP both in terms of nuance — what might shift the FOMC from its anticipated course — and indicate the Fed's confidence in its forecast."
After the previous meeting, Low said, "Powell seemed genuinely puzzled at reporters' concern about the job market. At this one, we'll be looking for signs the FOMC is at all concerned, too."
But traders will focus on what Powell says "about employment and growth, especially if Powell does admit the Fed thinks the job market has slowed excessively, because those are the more significant factors during the initial easing phase."
If the easing cycle follows tradition, he said, "the economy and job market should stabilize and revive after the first two or three rate cuts. Maybe after the first three or four this time, given how much higher the fed funds rate is now compared to where it was at the start of tightening."
Since recent data indicated "labor markets are not deteriorating as quickly as initially feared and that inflation remains a factor to be considered," DWS U.S. Economist Christian Scherrmann said, "we expect the Fed to cut rates by 25 basis points not only in September but at all remaining meetings through 2024."
The Fed will remain data-dependent, he added. As for the SEP, "We expect a somewhat more moderate path than the markets are currently pricing in, as we believe central bankers will want to avoid a dovish race to the bottom that could prove counterproductive," Scherrmann said.
In the press conference, "we expect Powell to strike a dovish but balanced tone, as we believe this best fits the current data: labor markets appear to be in equilibrium, excess demand is fading, and disinflation is continuing but at a slower pace," he said.
Andrzej Skiba, head of BlueBay U.S. Fixed Income at RBC GAM, expects 75-100 basis points of easing this year. "We think the market has gotten ahead of itself by pricing in 120 basis points of cuts this year," he said.
Don't expect a recession, he said, since "companies are not laying off employees. Employment remains strong and this is helping the consumer. There has not been any material pickup in layoff data and that's a big deal."
Job growth "is still respectable," keeping downward pressure on the unemployment rate and doesn't suggest a recession, said
"The critical context is that most Fed policymakers (and many investors) have concluded that inflation will continue to moderate," he continued. "If true, the significant risk for the U.S. Fed is remaining 'restrictive for too long' and unnecessarily tipping the U.S. economy into a downturn. I suspect most policymakers will view the August jobs report in that light and therefore be eager to cut rates."
The Fed is likely to cut a quarter-point at the three remaining meetings this year and six times next year, Van Hesser, chief strategist at Kroll Bond Rating Agency, told The Bond Buyer. "There's obviously been a lot of chatter around the possibility of 50 basis points, and our view has been that there's just no need for it."
The Fed likes to move 25 basis points at a time "unless there's a shock," Hesser said, "and nothing suggests a shock to us."
Neutral is 3%, Hesser estimated, and the Fed will be data-dependent after this year. "I don't think we have to get to 3% necessarily next year. I think the risk there would be to the upside."
The SEP will be revised slightly higher for both unemployment and gross domestic product growth, he said,
Hesser said he recalls Powell saying at a press conference "the thing that keeps him up most at night is trying to find that balance between taming inflation convincingly and sustainably while maintaining growth. And I think he just might pull this off."
BMO still expects a 25 bp cut this month, said Chief Economist Douglas Porter, "but what has changed for us is what happens afterwards — given the calmer, much-improved underlying inflation landscape, as well as the rise in joblessness to above 4%."
The Fed will cut in a "steady series" of a quarter point through the first half of 2025, "ending at just below 3% by early 2026."
If the labor market "weakens materially further," Porter said, the cutting could be faster and deeper.
"One of the greatest identifiable dangers to the economy and markets today is that the Fed, by acting too aggressively or talking too negatively, increases the risk of the economy falling into recession," said David Kelly, chief global strategist at JPMorgan Asset Management.
The Fed, he believes, understands that and will be cautious. "We expect the Fed to cut the federal funds rate by 25 basis points, rather than 50, and, in doing so, highlight their satisfaction with progress on inflation rather than any worries they might have about economic growth."
