Fed Preview: Forecasts from 10 major banks, crushing rate cut prospects

Inflation has performed better than the FOMC forecast in September, which is likely to result in lower projections for inflation and the FFR. The dot plot could be at least 50 bps lower over the next year relative to the September projection. Powell will need to maintain hawkish guidance as the job of combatting higher inflation is far from done and the FOMC doesn’t want to run the risk that financial conditions ease too much as that could undermine its objective of getting inflation sustainably back to 2%. 

We expect the central bank to hold rates steady and signal a soft tightening bias. Further out, they see a mild recession starting in Q1 2024 and a first rate cut in June.

We expect the FOMC to remain on hold, stress its data dependence and intention to proceed carefully. During the press conference, we expect Powell to repeat that it would be premature to conclude with confidence that monetary policy has achieved a sufficiently restrictive stance or to speculate on when policy might ease. However, we expect the FOMC to remain on hold in the coming months because they think a soft landing is in sight and they are not likely to risk it by hiking further. Nevertheless, we think that unemployment will rise higher than anticipated by the FOMC, which will prepare them for a first rate cut in June. Meanwhile, given the Fed’s data dependence, it will continue to be very difficult to push back convincingly against market expectations of an early rate cut.

The Fed is expected to extend its pause to rate increases for a third consecutive meeting. In our view, the recent tumble in yields poses a challenge for Fed communications as the likely dovishness expressed through the statement and the SEP might overstate the pricing for rate cuts. In light of this, we expect Powell to push back on the idea that mission has been accomplished. The Fed will fail to send a hawkish signal, especially with a downward revision to the SEP. While, this will weigh on the USD on Fed day, we caution that data remain in the driver's seat. Data in aggregate point to further downside for the USD, but we are cautious of chasing it into year-end and into US CPI. The broad direction of travel for the USD is lower with the risk of non-sticky rallies in the near-term.

We expect the new economic projections to revise the outlook for inflation lower, but higher for GDP. They will remove the additional rate hike and still call for 50 bps of cuts next year. Far less than the 125 bps the market is calling for. Whether it will be a big enough wake-up call for the market is still unknown. This is at least the 6th time the market is pricing near-term rate cuts in this cycle, we are not sure they have gotten it right this time either.

Fed officials tend to keep policy options open. They should embrace no further hikes following the December FOMC meeting, but at the same time, wish to avoid adding to market speculation on the timing and magnitude of cuts in 2024. It is a fine balancing act, achieved by indicating they are not yet discussing cuts and maintaining the two cuts signalled in the September dot plot.

The Fed is widely expected to leave the Fed funds target range at 5.25%-5.50%. The bigger story is likely to be contained in the individual Fed member forecasts – how far will they look to back the market perceptions that major rate cuts are on their way? We strongly suspect there will be a lot of pushback here. We expect the Fed to retain a relatively upbeat economic assessment with the same 50 bps of rate cuts in 2024 they signalled in their September forecasts, albeit from a lower level given the final 25 bps December hike they forecasted last time is not going to happen. We think the Fed will eventually shift to a more dovish stance, but this may not come until late in the first quarter of 2024. The US economy continues to perform well for now and the jobs market remains tight, but there is growing evidence that the Fed’s interest rate increases and the associated tightening of credit conditions are starting to have the desired effect. We look for 150 bps of rate cuts in 2024, with a further 100 bps in early 2025.

The Fed is expected to keep the policy rate unchanged but communication and SEP dot revisions might skew somewhat dovish. We expect that the Fed will revise their 2023 core PCE inflation lower and given that officials did not deliver the last hike they had anticipated in 2023, it is likely that the 2024 and 2025 median dots in the SEP move lower by 50 bps to 4.625% and 3.375%, respectively. The 2024 dot would then imply 75 bps of cuts in total for 2024, more than what the dots were showing in September. During the press conference Chair Powell will likely say that it is premature to speculate about cuts and that the Committee will decide meeting by meeting if it needs to hold rates steady or to raise the policy rate.

The FOMC has no reason to alter course, and is too divided about what lies ahead to offer definitive guidance, although Powell’s team isn’t likely as dovish as the market in terms of the timing of the first rate cut.

It is almost a given the FOMC and Chair Powell will continue to highlight that inflation risks remain their primary focus. Though discussion in the press conference is also likely to include an assessment of the downside risks for growth and the labour market as well as recognition that, without cutting nominal interest rates, the real stance of policy will continue to tighten as inflation eases. If our March start date for cuts is correct, come the January meeting, activity is likely to take over from inflation.