The Fed offered something for everyone today, offering a sizable interest rate cut for doomsayers, but also an upbeat assessment of the US Economy for those who are more optimistic.

The Fed cut interest rates by 50 basis points at its September 2024 Federal Open Market Committee (FOMC) meeting (Figure 1). This probably reflected mounting concerns about downside risks to the labor market as hours are being cut in some parts of the country and payroll employment over the last year or so might be revised downward.

However, the Fed did provide a rather glowing assessment of the US economy, believing GDP growth remains solid, the labor market is still healthy, and inflation is trending back to the 2-percent target. Moreover, the Chair of the Fed did not believe the economy is susceptible to a shock that would cause an economic downturn.

Markets and observers were divided over whether the central bank would start its rate cutting cycle to reduce monetary policy restrictiveness by 25 or more basis points. The decision to cut by one half percentage point was not unanimous, as one governor dissented, preferring a 25bp cut. Indeed, we believed 25bp would have been sufficient to start as the economy is not exhibiting material stress and is likely not on the cusp of recession.

Still, the Summary of Economic Projections (SEP) (Figure 2) suggested that the Fed will cut interest rates gradually over the course of the next year or so. The SEP points to another 50 basis points of cuts in 2024, and another 100 basis points of cuts in 2025 (Figure 1). The SEP also reveals that FOMC participants believe interest rates will stabilize in 2026 at a level that is higher than the prevailing norms before the pandemic.

Figure 1. Fed cut Rates 50bp in September 2024 but suggests gradual policy reduction ahead

Sources: Federal Reserve Board and The Conference Board projections (light blue line) and approximations for Fed policy path (red line).

Trusted Insights for What’s Ahead™

• Consistent with our own observations, the FOMC judged that the US economy is in good shape on the GDP growth, labor market, and inflation fronts. The Fed also stated that risks to the labor market and inflation are roughly in balance.
• However, it is apparent that the committee has concerns about risks to both sides of its dual mandate: maximum employment and price stability.
• Notably, the Fed appears more concerned about downside labor market risks given soundings of some regional cuts to hours from the Beige Book, and data suggesting payroll gains to-date have been too strong.
• While the Fed began the new phase of monetary policy with a bold move, it is not apparent that subsequent cuts will be as large, nor that cuts would take place at consecutive meetings.
• The Fed indicated that it remains highly data dependent and will determine the pace of cuts meeting by meeting. Moreover, it is poised to adjust its course as needed if the data resist the attainment of its goals.  
• Given the updated projections in the SEP, we feel comfortable with 50 basis points of additional cuts in 2024, placing the federal funds rate target range at 4.25 to 4.50 percent by December, which matches FOMC participant expectations. We posit 25 basis points cuts may be appropriate at each the November and December 2024 meetings.
• We also maintain our call for 125 basis points of interest rate cuts in 2025, with the fed funds rate target landing at 3.00 to 3.25 percent by December 2025, versus the SEP projection of 100 basis points of cuts or a target range of 3.25 to 3.50 percent by end-2025.
• However, we differ on the expected terminal rate for the federal funds rate target range. We anticipate the rate target settling at 3.00 to 3.25 later in 2025 and remaining there, while the Fed’s SEP projected the target to fall to 2.75 to 3.00 percent sometime in 2026 and holding there.

FOMC Meeting Highlights

Something for Everyone

The Fed attempted to thread the needle today, offering something for everyone. For investors and observers who feel the economy is under stress and that Fed is behind the curve in reducing it degree of restrictiveness, the FOMC cut by 50 basis points. For others who believe the economy is not in serious trouble and a smaller cut was warranted, the Fed took great pains to explain that economic data to date reveal solid growth, a low unemployment rate, and inflation, while trending towards target, that remains elevated.

Don’t Panic

Importantly, the Fed Chair stated at the press conference that the 50-basis points interest cut did not reflect a belief among policymakers that they are behind the curve on reducing restrictiveness, but was instead a sign that the Fed does not want to get behind. Moreover, the large cut reflected the Fed’s greater confidence that inflation is moving sustainably to 2 percent, even while there are few signs that the US economy is under duress.

50bp in September Does Not Mean Go Big Every Meeting

While the Fed did go big in terms of interest rate cuts at the September meeting, the SEP looks for an end-2024 federal funds target rate of 4.4 percent (or a range of 4.25 to 4.50 percent). This would mean another 50 basis points of cuts by December. If incoming economic data cooperate, we posit it means two 25 basis points cuts – one in November and one in December – or a 50-basis points cut in December skipping the November meeting if data are somewhat stronger-than-expected. However, if the economy does weaken materially and inflation falls faster, then there could be deeper cuts before yearend.

Fed Looks to Cut Rates Gradually

On balance, the policy statement and the Fed Chair’s press conference comments indicate that ahead of every meeting the Fed will assess the pace and size of interest rate cuts based upon incoming data. The cutting cycle is not on a predetermined path, meaning markets and observers should not expect 50bp of cuts at every meeting. Looking out over the rest of the forecast horizon, the SEP suggests gradual interest rate cuts over the course of 2025 and 2026, with the possibility of skipped meetings or even pauses in cuts to assess the impact on the economy. The SEP anticipates a fed funds rate target of 3.4 percent (or 3.25 to 3.50 percent) by the end of 2025 and a rate of 2.9 percent (or 2.75 to 3.00 percent) by the end of 2026.

The Days of Super Low Rates are Over

As the SEP’s 2027 and longer-run federal funds rate target projections were also 2.9 percent, policymakers expect the target to stabilize at a range that is higher than the 1.50 percent average (or -0.5 percent average in real terms) over the period between the Great Recession and the pandemic. Indeed, the Fed Chair stated at the press conference that the US is likely not returning to the days of very low interest rates that many were accustomed to before the pandemic. We think the fed funds rate target may stabilize at 3.1 percent (or 3.00 to 3.25 percent) by the end of 2025. Either way, high interest rates for the foreseeable future are the most likely for the US going forward.

Upward Inflation Pressures to Endure

We agree with this principle as there are more structural drivers of upward inflation pressures, that will require higher interest rates to keep inflation at the 2-percent target. Some of these dynamics include limited housing supply, persistent labor shortages as Baby Boomers retire, rising insurance premiums (e.g., home due to more destructive climate events, auto due to more high-tech and easily damaged vehicles, and medical as the population ages), higher goods prices amid deglobalization and reshoring of global supply chains, and the upfront costs of building out infrastructure and making capital investments for the energy transition. The advent of more accessible forms of Artificial Intelligence, increases in productivity, and a potential desire among companies to remain competitive, will provide downward pressures on inflation ahead. However, we think upward pressures will more than offset downward pressures.

Low Risk of Recession Ahead

The September SEP revealed revisions to the US economic outlook relative to the June SEP that were roughly in-line with our expectations. The Fed unsurprisingly downwardly revised its real GDP forecast for the end of 2024 from 2.1 percent Q4/Q4 to 2.0 Q4/Q4. This was still higher than our 1.6 percent Q4/Q4 forecast for 2024, which does include tepid growth in H2 2024 but no recession. The FOMC’s 2.0 percent real GDP projection for 2025 through 2027 was unchanged. The SEP projections suggest a low risk of US recession over the projection period among FOMC participants. Moreover, the Fed’s projections appear generally more optimistic than our own over the medium term, as we anticipate real GDP growth will fall below potential (~2.0 percent according to CBO estimates).

Slightly Higher Unemployment

The Fed did raise its end-of-year unemployment rate forecasts for 2024 (by 0.4 percentage point to 4.4 percent), 2025 (by 0.2 percentage point to 4.4 percent), and 2026 (0.1 percentage point to 4.3 percent). The rates are higher than our year end projections (4.3 percent in Q4 2024 and 3.9 percent in 2025). Additionally, the 4.4 percent peak will last longer than we currently forecast. Nonetheless, the SEP does not portend a surge in unemployment and projects that the unemployment rate will remain close to the natural rate over the next few years. Moreover, the SEP anticipates the 4.2 long-run unemployment rate will average just below the natural rate (~4.4 percent), portending a relatively healthy labor market ahead. The natural rate of unemployment is the rate at which the labor market is neither placing upward or downward pressure on inflation.

Lower Inflation Expectations

Not surprisingly, the Fed also reduced its Q4/Q4 expectations for both total and core (i.e., total less food and energy) Personal Consumption Expenditure (PCE) deflator inflation in 2024 and 2025. This probably reflects the material strides elevated interest rates have made in cooling inflation over the last few quarters after the pace of slowing stalled in Q1 2024. The Fed’s inflation expectations are slightly higher than our forecasts, and we expect PCE inflation to reach the 2-percent target by mid-2025, while the Fed seems to expect stabilization at the 2-percent inflation target sometime in 2026.

Figure 2. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under their individual assumptions of projected appropriate monetary policy, September 2024 (Percent)

Source: Federal Reserve Board.