Monetary Policy & Inflation | US
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Summary
- Relative to the June SEP, inflation is roughly in line, but growth and unemployment are tracking above the Fed Q4 2024 forecast.
- The FOMC’s positive outlook and intention to remain nimble suggests the easing cycle will start with one cut in September.
- Recent comments from FOMC members suggest the September median dot will show three 2024 cuts.
Market Implications
- I expect the Fed to cut once in September and three times by December.
Recent Economic Developments
Compared with the June SEP, core PCE is roughly in line, and growth and unemployment above the Q4 2024 FOMC forecast (Table 1).
Core PCE has continued to slow (Charts 1-2). Shelter inflation, the stickiest price category, slowed in June but recovered in July (Chart 3). Average wage growth is roughly at the level the Fed considers consistent with 2% inflation or 3.5% based on 1.5% growth in labour productivity (Chart 4).
Growth remained strong at 3% YoY on average over H1. The Fed GDP nowcasts shows Q3 growth at or above 2%, i.e., above the 1.8% the FOMC sees as trend (Table 1, Chart 5).
At Jackson Hole, Fed Chair Jerome Powell saw labour market conditions ‘less tight than just before the pandemic in 2019.’ Since then, NFP have slowed markedly, to an average of 115,000 in July-August, from an average of 147,000 in Q2 and compared with a 2019 average of 166,000 (Chart 9).
Unemployment fell to 4.2% in August but is still 90bp over the level of 2023. Powell sees the rise as reflecting mainly higher labour supply and hiring normalization ‘from a previously frantic pace.’ Powell sees the unemployment rate as ‘still low by historical standards.’ In any event jobless claims are falling (Chart 10).
Vacancy ratios have fallen though the spread between hiring and separation rates remains positive and on par with 2019 (Charts 11 and 12).
FOMC Agrees to Start Easing
At Jackson Hole on 23 August, Powell announced the Fed would start easing at the September FOMC. He stated, ‘my confidence has grown that inflation is on a sustainable path back to 2 percent.’ He saw the economy ‘continuing to grow at a solid pace’ but the ‘upside risks to inflation have diminished’ while ‘the downside risks to employment have increased.’ Powell added ‘we do not seek or welcome further cooling in labor market conditions.’
In recent speeches, FOMC members have concurred to various degrees (Table 2).
On the hawkish side, Governor Bowman and Kansas City Fed president Schmid want to proceed with caution and see more data before supporting a cut. Because dissents are rare at the Fed, Bowman and Schmid are likely to sign off on a September cut but could pencil in only one 2024 cut.
On the dovish side, Chicago Fed president Goolsbee is concerned the Fed is already behind the curve. Goolsbee could therefore submit a dot showing four 2024 cuts.
In between these two extremes, recent comments from Powell, Waller, Williams, Daly, Collins and Harker suggest their dots could show three 2024 cuts. Because of their hawkish bias, I see recent comments from Kashkari and Musalem signalling their dot will show only two 2024 cuts.
Overall, I am expecting the dot plot to show three 2024 cuts as the median, up from one cut in the June SEP and two cuts in the March SEP (Chart 14).
In addition, I expect the FOMC to cut only 25bp this month, largely due to their sanguine economic outlook. Furthermore, Waller, one of the more influential members, has stressed the need for policy nimbleness, which suggests starting with 25bp. I believe Waller’s plea for nimbleness reflects a number of uncertainties, political and economic, which I will discuss more fully in my Fed preview.
Market Consequences
I expect one cut at the September FOMC and three cuts by end-2024 against markets pricing 1.3 cuts in September and 4.4 by December (Chart 13).
Current Fed Macroeconomic Forecast
Recent FOMC Comments
Dots Detective
Inflation Risks Down, Employment Risks Up
Markets Overpricing Fed
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Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
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