Federal Reserve’s Shifting Outlook Spurs Speculation on Earlier and Deeper Rate Cuts

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The recent shift in the Federal Reserve’s stance has stirred up expectations in the markets, with a growing anticipation for rate cuts earlier than previously predicted in 2024. These potential cuts are also presumed to be more substantial than what the Federal Reserve had initially forecast.

As of Thursday, markets are indicating an approximately 80% probability of the first rate cut happening in March, according to the CME Fed Watch Tool. This aligns with Goldman Sachs’ latest forecast, which, within a week, adjusted its projections for rate cuts from the fourth quarter of 2024 to March.

Goldman Sachs referenced the Fed’s commentary on inflation moderating faster than expected and recent data showing lower inflation than anticipated. This led them to predict three consecutive 25 basis points cuts in March, May, and June, resetting the policy rate due to what they perceive as a potential misalignment.

The Fed’s Summary of Economic Projections released on Wednesday, including the “dot plot,” indicated that Fed officials foresee 75 basis points of interest rate cuts in the coming year, 25 basis points more than previously estimated. The central bank also expects core inflation to peak at 2.4%, lower than their previous projection of 2.6% in September.

However, investors have gone further in their estimations. Before the November Fed meeting, Bloomberg data suggested only three rate cuts for the next year. Now, after two unchanged benchmark interest rate decisions and a brighter inflation outlook, investors foresee as many as seven rate cuts by January 2025.

Despite this, not all economists agree with the aggressive market predictions. EY Chief Economist Greg Daco cautioned that while a soft landing might seem plausible, challenges persist for the US economy. Consumer caution due to sustained elevated costs post-pandemic might affect spending patterns, potentially impacting the economy in 2024.

Daco emphasized the importance of a stable labor market and highlighted that the Fed’s readiness for cuts doesn’t necessarily validate the extent of market expectations. He warned against excessive enthusiasm regarding a scenario where the Fed rapidly slashes rates, indicating that such actions would typically occur during a recession.

Echoing similar sentiments, other economists like those from Wells Fargo, Morgan Stanley, and Deutsche Bank, anticipate rate cuts starting in June. They cite reasons such as the Fed’s need to maintain higher rates amid robust employment growth and persistent inflation. However, they also anticipate eventual rate cuts as the economic landscape shifts.

Wells Fargo’s economists underscored that the depth of the economic slowdown will determine the pace of rate cuts. If a recession unfolds, they foresee deeper cuts by early 2025, exceeding current market expectations. Conversely, a milder slowdown would result in a slower pace of rate cuts.

The recent decision by the Federal Reserve to maintain interest rates at a high level of 5.25% to 5.5% underscores their observation of cooling inflation, signaling a potential shift away from rate hikes and possibly toward rate cuts in the upcoming year.

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