FOMC preview: Fed telegraphed this one well

Judith Raneri, senior vice president and portfolio manager of GABXX at Gabelli
While the economy remains "resilient," signs of slowing growth have emerged, said Judith Raneri, senior vice president and portfolio manager at Gabelli.

Members of the Federal Reserve have telegraphed their intentions, analysts said, and will cut the fed funds target rate by 25 basis points this week, bringing the range to 4.50% to 4.75%, but the consensus beyond that weakens.

"While a 25-basis-point cut is likely [at this meeting], the upcoming jobs report will be crucial in shaping the Fed's December decision," said Judith Raneri, senior vice president and portfolio manager of GABXX at Gabelli. "Weaker job growth could reinforce the need for additional cuts, while stronger results might prompt [Fed Chair Jerome] Powell to consider pausing in December, contingent on further economic data."

While the economy remains "resilient," she said, signs of slowing growth have emerged. Record-high credit card debt may portend financial strain, Raneri noted.

As for the press conference, "Powell is expected to emphasize stability in the labor market reflecting recent declines in unemployment in August and September and balance in the Fed's inflation and employment targets," she said.

Charlie Ashley, portfolio manager at Catalyst Funds, expects quarter-point cuts in both November and December. "We are confident that we will get a 25-bp cut in November given that recent readings on inflation, employment, and gross domestic product have not been significantly outside of expectations."

Looking to next year, he said, if inflation continues cooling, the Fed could hit the dot plot projection of a 3.375% rate, "but we also think there is a good chance that the Fed will pause rate cuts before getting down to the 3.375% level."

Federal deficits will continue no matter who wins the presidential election, which "will put upward pressure on inflation if the economy remains strong," Ashley said.

While a 25-bp cut is the base case, D.A. Davidson Director of Wealth Management Research James Ragan said, he "can make the case for a pause (no cut) due to reported economic data continuing to exceed expectations."

Strong GDP data raises concerns since "ongoing above-trend growth could rekindle inflation," Ragan said. "3Q24 GDP strength would be the basis of the argument for pausing in November and holding fed funds unchanged, but we still believe that Fed will do the 25bps."

He noted the two-year Treasury yield has risen 59 bps since the September FOMC meeting and the 10-year yield has spiked 68 bps. While strong economic data is the largest driver of the moves, Ragan said, other contributors are that the market is pricing in a Trump win and bond investors' concern about the budget deficit and rising federal debt.

In addition to the rate cut, Ragan said, markets want "to hear a similar message from Chair Powell that he delivered in September": that upside inflation risks have lessened and downside risks to employment grew.

A weaker labor market in 2025 will slow the economy, he said. "This is likely to support additional Fed rate cuts, and we could see a 3.5% fed funds target by the end of 2025. If U.S. economic growth remains positive, then longer term yields (10-year Treasury) could remain higher than expected. A meaningful drop in long-term yields would likely reflect a more severe slowdown in the economy requiring the Fed to lower rates more aggressively."

While the consensus for this meeting is solid, Mark Malek, CIO at Siebert, said, the December meeting gets "more interesting," with futures suggesting a 70% probability of another 25-basis-point cut, but overnight swaps implying 47% probability. Data will determine the movement of the probability.

Still with the Fed's larger-than-expected cut in September, "there is still likely a respectable probability that the Fed will hold off until December." Also, he said, Treasury yields' recent rise "serves as a market-based monetary tightening tool."

Handicapping 2025 is more difficult, as moves "will depend on the outcome of the presidential election," Malek said. "Inflation is under control, and with rising unemployment we can expect further cuts as a default choice. But a Republican win bringing back higher spending and tariffs might re-awaken inflationary pressures."

The weak employment report "should ensure that the Fed will cut rates by 25 basis points" this week, according to Brian Rose, senior U.S. economist at UBS Global Wealth Management, since Powell said he doesn't want additional job market weakness.

UBS expects quarter-point cuts this month and next, with another 100 bps of easing in 2025.

Morgan Stanley also sees quarter-point cuts at the last two meetings this year, with signs of progress on inflation and upgraded assessments of growth. "In the press conference, we doubt Chair Powell commits to a size or cadence for future cuts; decisions will depend on the data."

Despite "significant" noise ahead of the meeting, Brian Kennedy, portfolio manager of the full discretion team at Loomis, Sayles & Co., expects a quarter-point cut.

The Fed will look past "weather and labor issues" that likely curtailed payrolls last month, he said. "We would expect the committee's statement to be consistent with previous statements in terms of relying on future data to help set policy."

The strong September payrolls figures and expansionary ISM services data offer explanations for limiting this cut to 25 bps, Kennedy said.

With this meeting's results expected, Erik Weisman, chief economist and portfolio manager at MFS Investment Management, said, "The bigger question is whether the Fed might skip cutting in December. Given that the Fed has very clearly stated that it is highly data dependent, it is too soon to have a firm view on this question."

With indicators suggesting better-than-expected economic performance and "a modestly higher inflation rate than anticipated … the market has gradually been pricing a less aggressive Fed, with a terminal policy rate that is expected to be somewhat higher," he said.

The election "could have an outsized impact on the macro forecast," Weisman said. If Donald Trump regains the White House, it "is likely to be viewed as ushering in a more inflationary environment, whereas a win for Vice President [Kamala] Harris will probably be seen as closer to the status quo. And while the Fed is unlikely to react to the results of the election in the near term (abstracting from a disputed election), the market may have other ideas."

Andrew Husby, senior U.S. economist at BNP Paribas, said, "The statement is unlikely to see major changes, but may highlight special factors that weighed on the latest U.S. jobs report. We see that report as consistent with an ongoing economic soft landing, and as reinforcing our base case for 25bp cuts through March 2025."

Don't expect any discussion of the monetary policy implications of the election, he said, as "it will likely be too early" for that.

"If the markets were confused about where the Fed Funds rate was going last month, this month should be even more confusing," said Byron Anderson, head of fixed income at Laffer Tengler Investments. "Markets are convinced of a cut at the November meeting but we have seen decent economic data from GDP, productivity, consumer spending, unemployment and inflation but maybe they shouldn't be."

The "Fed is more data dependent now than they were when it actually called itself data dependent," he said. Prepare for "range-bound yield volatility," he warned based on data swings.

"We should continue to see more expected rate cuts fall out of the futures market with economic data trending positive but at some point, yields will start to bite the economy and the consumer again," Anderson said.

Volatility over the next year will "hamper" the rate cut cycle, he said, "unless we see a credit issue emerge, which isn't evident at the moment."

The inflation outlook and other uncertainties remain, said DWS U.S. Economist Christian Scherrmann. "As the weakness in the labor market appears to be more a product of data quality and volatility, inflationary pressures — while receding — still appear to remain a significant factor. We also believe that demand remains sensitive to expectations of lower interest rates."

The election results may take days, he said, "and the outlook for fiscal or trade policy is an important input into monetary policy decisions. At a time when the Fed is trying to win the battle against inflation, stimulating demand could be counterproductive."

While Scherrmann sees a 25 bp cut this meeting, "the December meeting, we think will be a closer call as to whether we see another cut or whether the Fed pauses monetary policy normalization. By then, at least, we should have a clearer picture of what to expect from lawmakers."

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