Let’s be clear: All forecasts for the trajectory of Fed funds are guesses.

Anything can happen. Just ask the last five years, during which the Fed was compelled to i) pivot away from a shallow hiking cycle amid a trade war and incessant criticism from a boisterous US president with a bad social media habit, ii) return to the lower bound due to a pandemic, then iii) hike rates rapidly in the face of spiraling inflation exacerbated by the first land war in Europe since the Reich.

Given the sheer quantum of indeterminacy that defines the current macro backdrop, projections for Fed policy can be fairly described in 2023 as pure guesswork. That as opposed to the mostly guesswork characterization that always applies.

Be that as it may, market participants were interested in Goldman’s latest efforts to map the future for Fed funds. The bank regularly updates its Fed call as conditions warrant, but the note which grabbed a few headlines late Sunday and into Monday was a bit more expansive than usual.

Long story short, Goldman expects the Fed to start cutting rates in Q2 of 2024, when core PCE should be “below 3%.” “The motivation for cutting outside of a recession would be to normalize the funds rate from a restrictive level back toward neutral once inflation is closer to the target,” the bank’s David Mericle wrote. Goldman sees the funds rate “stabilizing” at 3-3.25% after a series of 25bps, quarterly reductions.

As far as these sorts of updates go, there was actually a lot to like about Goldman’s latest, which touched on several key policy debates. I’ll get to those later. For now, I wanted to highlight the main points. The figure below summarizes where the bank expects key macro variables to be at the onset of what Goldman suspects will be quarterly cuts.

What sticks out in the table above are the very low unemployment rate figures seen for Q2 2024 and the projection for the Employment Cost Index. Simply put: If Goldman’s forecasts are correct, the Fed would be commencing cuts with a jobless rate that’s more than two full percentage points below that which persisted at the onset of an allegedly comparable cutting cycle, and a YoY pace of compensation cost growth that’s a full percentage point higher.

Those disparities, along with the simple fact that the US economy has so far been reluctant to decelerate in a way that’s conducive to the below-trend growth the Fed is explicitly attempting to engineer in the service of the inflation fight, casts doubt on the timing of any rate cuts. Goldman readily conceded as much.

“Normalization is not a particularly urgent motivation for cutting, and for that reason we also see a significant risk that the FOMC will instead hold steady,” the bank wrote, adding that “the FOMC might not cut because inflation might not fall enough or, even if it does, because solid growth, a tight labor market and a further easing of financial conditions might make cutting seem like an unnecessary risk.” Indeed.

The figure on the left, below, shows the subjective odds Goldman assigns to various scenarios. I wouldn’t call the baseline “high-conviction” at just 35%.

The figure on the right shows how the probability-weighted version of Goldman’s outlook aligns (or, more aptly, still doesn’t align) with market pricing.

“We are far from certain and have long put substantial probability weight on an outcome where the FOMC does not cut in our Fed funds rate scenario analysis,” Mericle went on, emphasizing that “normalization for normalization’s sake is not a particularly urgent motivation for cutting and it could be overridden by other concerns.”

He drew a very good parallel with the last hiking cycle, which began under Janet Yellen. Those of you with “long” memories might recall that liftoff was delayed by two months in 2015 by turmoil in China tied to the PBoC’s overnight yuan devaluation. Over the ensuing six months, deflation fears proliferated and the world succumbed to a kind of mini-recession, which was famously countered by the so-called “Shanghai Accord.”

“While there is no perfect historical analogy for a potential cutting cycle starting next year, this desire to normalize a policy stance that has become inappropriate rather than to solve an immediate problem is somewhat similar to the motivation for hiking last cycle,” Mericle remarked, referencing the notion that the Fed began raising rates in 2015 not because they needed to, but rather because there was something odd about persisting in emergency policy settings seven years on from the actual emergency. Policy had become anachronistic.

Mericle continued. “One lesson from that episode is that because the purpose was not urgent, when a risk emerged after the very first hike in the form of a manufacturing slowdown, the FOMC decided to stop for a while,” he said. One implication: If the Fed were to venture a cut early next year and inflation persisted or picked back up, it could be quite a while before the second cut.