Fed Readies for Rate Cuts: Back Toward Neutral, or Mid‑Cycle Adjustment?

U.S. Federal Reserve Chair Jerome Powell’s confident press conference following the March meeting coupled with revised Fed projections suggest Fed officials are determined to cut interest rates this year – most likely starting in June. Fed officials signaled that it would take a dramatic turn of events to knock them off this course. The median interest rate forecast for 2024 did not change from three 25-basis-point (bp) rate cuts by the end of 2024, despite upward revisions to the inflation forecasts.

We believe the very modest upward adjustment in the expected path of interest rates past 2024, despite a strong U.S. economy and recent stickier inflation readings, suggests that the Fed views the competing risks (recession versus persistent inflation) as reasonably balanced now. So if core PCE inflation (personal consumption expenditures, the Fed’s preferred measure) remains within the “2-point-something” zone – not far above the 2% target – when Fed officials meet in June, we expect they will cut.

Bumps in the road, or embedded stickiness?

While our baseline is that U.S. core PCE inflation should moderate to 2.5% in the second quarter after accelerating above 3% in the first quarter, we continue to expect PCE to remain above-target absent additional labor market easing.

Chair Powell dismissed the reacceleration in core PCE as part of a bumpy path toward lower inflation. However, we’re concerned that still above-target wages, the reacceleration in the core services ex shelter measure, sticky rental inflation, and fading tailwinds from lower goods prices all mean that getting inflation sustainably back to 2% may take more time – and require a weaker economy.

Underscoring how much the Fed’s reaction function around inflation risks has shifted, Fed officials’ median core PCE inflation forecasts are the same in March 2024 as they were in September 2023, yet the Fed is now projecting an interest rate path for 2024 that is 50 bps lower.