Fed Signals Three Rate Cuts For Next Year At Final 2023 Gathering

The Fed kept rates on hold for a third consecutive meeting on Wednesday, as widely expected.

Beginning in October, officials telegraphed a tentative inclination to skip the final rate hike tipped by the September dot plot amid a sharp selloff at the long-end of the US Treasury curve which served to tighten financial conditions. The Committee inserted the financial conditions talking point in the November policy statement, and although Jerome Powell endeavored to emphasize that such tightening would only be relevant for monetary policy if it proved “persistent,” his admission that the dot plot’s relevance “decays” between SEP meetings served as a de facto acknowledgement that barring clear evidence that inflation was poised to re-accelerate, rate hikes were likely finished.

And so it was that markets priced out all odds of a hike at 2023’s final policy gathering. Over the six weeks since last month’s meeting, various measures of financial conditions eased materially, and traders moved to price in more rate cuts for 2024, bets Chris Waller emboldened on November 28 when he discussed the possibility of insurance cuts to prevent the real policy rate from rising as inflation (hopefully) recedes.

The market’s rate cut wagers will now be weighed against a dot plot refresh which tips three rate cuts for 2024. If there was a “consensus” for the dots, it was that the Committee would either preserve the 50bps of cuts tipped in September by shifting the median 25bps lower or “add” a cut by shifting it 50bps lower. They chose the latter. You can draw your own conclusions as to whether that constitutes a dovish lean.

Note: There was no chance the new 2024 dot which come anywhere near market pricing (which, headed in, called for halfway between four and five cuts). The long run dot was unchanged. Apparently, signaling a higher neutral rate is still a bridge too far. I suppose you could argue the recent run of softer data helps make the case that we haven’t entered an entirely new macro regime that requires a higher equilibrium rate after all.

The forward guidance for rates — to the extent you can call it that — was left mostly untouched but there was a subtle tweak. The Fed said it’ll take into account all the usual factors “in determining the extent of any additional policy firming that may be appropriate.” The “any” is new. And it’s incrementally dovish.

Still, the Committee isn’t ruling out additional hikes. Or at least that’s what you’re supposed to believe. But when taken with the new dots and Waller’s remarks last month about being “increasingly confident” around the idea that inflation is on its way back to target, some critics will invariably argue that the Fed’s pretensions to two-way policy risk aren’t credible at this point. That at most, the Committee intends to hold terminal for as long as possible but has no actual inclination to hike again.

As for the new economic projections, the Fed sees the unemployment rate at 4.1% for 2024 and 4.1% for 2025. Those figures are unchanged from the September SEP. There’s still some tension between Powell’s insistence on the idea that additional labor market softening will be necessary to restore inflation to target and the demonstrable absence of any such softening either in the actual data or in the projections. 4.1% hardly counts as a high unemployment rate, let alone November’s 3.7%.

The growth outlook was revised only slightly. The median forecast now calls for 1.4% growth in 2024 and 1.8% in 2025. The latter is unchanged from September, the former just a tenth of a percent lower.

The updated inflation forecasts suggest the Committee is incrementally more optimistic on the trajectory for core price growth, which will run 2.4% next year before returning (almost) to target in 2025. In September, the median core PCE projection for 2024 was 2.6%.

For what it’s worth, I don’t think it’s unrealistic to suggest core price growth will indeed return near target at some point over the next two years. It’s really more a question of whether it’ll stay there, or if we’ve now entered an era of elevated macro volatility inconsistent with the (already questionable) notion that economic outcomes can be micromanaged around a target level by a panel of technocrats.

The new statement described the US economy in relatively upbeat terms. “Growth of economic activity has slowed from its strong pace in the third quarter,” it read. “Job gains have moderated since earlier in the year but remain strong.” For the first time since February, the Committee braved a cautiously optimistic word on inflation which, while still “elevated,” has “eased.”