Now that the “when?” question has been answered, the next questions are “how low are rates going?” and “how fast will we get there?” Fed officials are data dependent but also trying to nail the elusive “soft landing.” This week’s data has been slightly “hot” as jobless claims dropped to the lowest level since mid-May. The employment picture can be described as “frozen.” Hiring and job openings have slowed but employers are not laying off employees. Perhaps the recent worker shortage and labor market tightness is influencing their strategy. Durable goods orders rebounded, corporate earnings reports are strong, etc. Futures markets now predict a 50/50 chance of a 50 bp vs 25 bp rate cut at the next Fed meeting. The 10-year Treasury is at 3.80% up from 3.62% last Tuesday (the day before the Fed announcement). Tomorrow’s PCE report will be closely watched; it is expected to indicate cooling inflation will allow Fed officials to “worry” about employment. (See the Fed’s “Inflation Nowcasting” preview of tomorrow’s PCE below. Note that the Fed predicts an even cooler report next month.)
This allows the Fed to concentrate on a “preemptive” strike on feared labor market weakness. Chicago Fed President Goolsbee provided insight in his remarks on Tuesday. Regarding last week’s cut and future cuts, he stated: “It was time to act and there will be more to come.” He spoke of getting the timing right and noted that “It’s hard at a moment like this where conditions are so different from previous cycles” (the old rules may not apply; we are in uncharted territory). He encapsulated the Fed’s “fear factor” when he said, “Labor markets tend to deteriorate quickly when they turn…monetary policy takes time to act.” Bottom line: cool inflation gives the Fed permission to act, and they are afraid of waiting too long, so they are acting preemptively.
How low will they go? To the “neutral rate,” the rate that is neither stimulative nor restrictive with an economy in “balance.” During the long period of near-zero rates in the 2010s, Fed Funds sat at 0.25% for years. The neutral rate was thought to be approximately 2.5% and it seemed like that was a “long way up.” As Powell remarked in his presser last week, “We are probably not going back to that era where there were trillions of dollars of sovereign bonds trading at negative rates.” So, where is it now? Let’s go to last week’s dot plot. The “longer run” predictions of the Fed Funds rate range from 2.50% to 3.75% (2026 and beyond). So, assuming the telegraphed pace of 2 more cuts this year and 100 bps in 2025, that will put the rate at 3.25% by early 2026. Atlanta Fed President Bostic remarked on the neutral rate this week. He said it’s likely in the 3.00% – 3.25% range, and that the rate was a subject of “robust” debate amongst Fed officials, adding that “it’s important no one think we’re in a mad dash to get to some neutral level.” Central banks worldwide are in early cutting cycles (see chart below). Stay tuned…
By David R. Pascale, Jr., Senior Vice President at George Smith Partners.
