Why One Bank Expects Massive Fed Cuts In 2024

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.”