Economics: Fed strives to prevent monetary conditions from easing
The gist of the FOMC statement and press conference overnight is that a successful inflation fighting strategy necessitates keeping monetary conditions tight for at least a few more quarters. Growth has turned out to be stronger than expected this year, and while inflation has been on a downtrend, the Fed still has a lot of work to be do. In our view, this work centres around keeping the markets at bay from expecting substantial rate cuts next year. If aggressive rate cuts get priced in, that would entail an easing of monetary conditions through an easing of long-term rates. That in turn would ease today’s monetary conditions, defeating the Fed’s objective to keep conditions tight for the time being.
Judging by the market’s reaction, the Fed seems to be on track, with equities and bonds both correcting following the press conference of Chair Powell. Our focus is less on how many Fed officials expect one more hike in this cycle and more on how they have shifted their expectation of only around 50bps in cuts next year. The latter is a far more hawkish signal for the markets than anything from the Fed this year.
We are however leaving our projections unchanged: the Fed won’t hike any further this year and cut by 100bps in 2H2024. We are maintaining this forecast in expectation of marginally weaker economic dataflow in the coming weeks, especially on the housing and labour market front. We don’t think it will take a lot for Fed officials to give up on an additional rate hike in this cycle.
As for next year’s projections, we think growth will be closer to 1% than the 1.5% or so projected by FOMC members. Most critically, this will come with sub-3% inflation and 4%+ rate of unemployment. A combination of lower growth and higher real interest rates would be sufficient to get the rate cut cycle going next year, in our view.
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