UBS has a bold forecast for the funds rate in 2024.
In a year-ahead outlook piece dated November 13, the bank suggested the Powell Fed may cut rates by 275bps next year. At least some of the cuts would have to be large. You’d need 11 “regular” cuts to get to 275bps. “These” may indeed “go to 11,” but there aren’t that many policy meetings in a year.
To call UBS’s forecast out-of-consensus would be an understatement. I’m not sure what “consensus” actually is for Fed cuts in 2024 (this being year-ahead outlook season, some forecasts are in the process of being refined), but market pricing is for around 75bps and the last dot plot tipped just 50bps.
“We expect the FOMC to lower the nominal funds rate next year first to calibrate the degree of restrictiveness as inflation falls faster than they expect,” the bank’s economists wrote. UBS anticipates the Fed commencing mid-cycle adjustment cuts when the spread between core PCE and the nominal funds rate reaches 2.5ppt, which they see at the March FOMC. “Then, if the economy ends up weakening as much as we expect, at some point the rise in the unemployment rate and contraction in the labor market should prompt a turn toward providing outright accommodation.”
As stated, there’s not a lot that’s controversial (or necessarily even notable) about that. It’s debatable whether the labor market will weaken enough to compel a pivot to overt easing (i.e., a Fed that goes from restrictive to loose in the space of 12 months from a three-handle UNR departure point), but it’s not completely implausible.
The scope of the cuts predicted by UBS is notable, though. The bank justified their view in part by noting that if past is precedent, the first signs of a weaker economy, and particularly negative payrolls, could be met with an outsized policy reaction.
UBS readily acknowledged that elevated inflation means the bar for rate cuts is higher, but noted that the onset of job losses, whenever it comes, will signal oncoming disinflation. “We expect retaining very restrictive policy would be pretty untenable in the face of outright job loss,” they wrote. “If inflation is at or below 2.0% and the unemployment rate is rising as we expect, even a so-called Taylor Rule would suggest rate cuts that are both swift and deep.”
The bank plugged their projections for inflation and the unemployment rate into a Taylor Rule and balanced approach rule assuming a neutral real funds rate of 0.5%, a 2% inflation target and 4% long run unemployment.
Note that UBS sees PCE inflation falling to 1.8% Q4/Q4 (so, below target) with barely positive GDP growth (0.3%) and an unemployment rate that jumps to almost 5% by the end of 2024.
“Under those assumptions, the central bank would cut rates fast and far,” UBS said. “The balanced approach rule, often cited by FOMC leaders in the past, would imply the federal funds rate should return to the zero lower bound.”
An underlying assumption of the call is that Powell sees the world the same way Bernanke and Yellen do. I don’t necessarily think that’s the case and believe Powell will be less eager than either of his predecessors to push for lower rates at the first sign of macro weakness.
Not really. The analysis dates back to 1980. You can’t analyze easing cycles (plural) under Bernanke and Yellen because with the exception of four years (2006-2008 and 2016-2018) their entire tenures were just one long accommodation cycle.
The availability of labor will be stymied by continued pressure on immigration levels. It will get much worse if Trump returns to office – Steven Miller rolls out the plans he has already laid out for everyone to read.
How do higher for longer interest rates help? I suppose if they can crater the economy, lay-offs would add to the pool of available labore. But at what cost?
Complete speculation, but I suspect Powell does think about his legacy. Not that he aspires to be Volcker II (that ship sailed a while back), but I do believe he is interested in putting a stake through the heart of ZIRP and in restoring the Fed’s credibility as an independent player in the economy.
If one year from now PCE inflation is <2%, GDP growth is ~0%, and UE 5%, then do I think the Fed will be cutting aggressively. With its inflation mandate met, FOMC won’t ignore its full employment mandate. Also, while the Fed is publicly apolitical, the Governors won’t have forgotten Trump’s abuse of the Fed. I think 275 bp in well under a year is far-fetched, but markets do extrapolate.