The Federal Reserve has raised interest rates by 5.25 percentage points since March 2022, the latest 25bp hike coming at the July 2023 FOMC meeting. This marks the fastest pace of hikes the U.S. central bank has had in 40 years and the highest rate since 2001.
The central bank’s tightening cycle is near its end, that is clear, but consequently, three pertinent questions are at the forefront:
This is the second of a three-part series to answer the aforementioned questions.
It was concluded that the tightening cycle was near its end and there would likely be, at most, one more 0.25% hike in November. The CME FedWatch Tool pointed to 97.0% and 64.6% probabilities for holds in September and November. Yet after the September pause, there is now a 96.2% and 73.1% likelihood of pauses on Wednesday, in November and the next month in December.
Indeed, it looks increasingly likely that the Fed plans to hold at their current 5.25% to 5.5% for a few reasons. Firstly, the 10-year U.S. Treasury Bond yield has risen sharply over recent weeks and now stands at 4.9% compared to 4.5% in September. In fact, Mary Daly of the San Francisco Fed argued this recent tightening in the bond market was broadly equivalent to another interest rate hike. Furthermore, economic data looks encouraging as core PCE inflation came in at 3.7% annual for September and lastly, wage growth began to slow. The Fed’s base case now appears to have shifted to holding rates at current levels, with higher rates becoming a contingency plan. Previously, it was the reverse.
Based on this above, it is sensible to suggest the Fed is near, if not already, at the end of its hiking cycle, which will divert attention to the potential for rate cuts as opposed to rate hikes.
At the September press conference, Chairmen Powell and the “dot plot,” which illustrates officials’ rate projections, suggested a ‘higher for longer’ narrative. Stocks began to selloff following the meeting as the market had priced in 1.0% of cuts in 2024 from Q1. Instead, it was now suggested that 2024 would bring no more than 0.5% and these would now come later in the year, likely in H2. The median participant at the September FOMC meeting expected a year-end 2024 funds rate of 5.1%, up from 4.6% at the June meeting. The median projected funds rate for 2025 moved up 50bp to 3.9%.
This perspective is also supported by top economists, such as World Bank President Ajay Banga, who are unanimous that global interest rates will remain ‘higher for longer.’ Moreover, this is now reflected in the CME FedWatch Tool, that sees the 2024 June meeting the first to have a probability of easing above 50%.
Most institutions in illio’s market summary research are in line with this H2 forecast and project rate cuts from June and the third quarter. Outliers include Goldman Sachs with rate cuts coming later in the year during Q4 2024 and Nomura forecasting cuts earlier in the year in Q1 2024.