If you want to know how much the Fed will cut interest rates next year, the top priority is to solve this problem!
This week, the Federal Reserve will use a “bitmap” to predict the path of interest rate cuts in 2024. Economists believe that the expectations of officials will be much more conservative than the market.
The most important question facing the economy and financial markets next year is not whether the Fed will cut interest rates, but why it will cut interest rates.
As inflation falls sharply from a decades-high, it seems increasingly likely that the Fed will cut interest rates in 2024. After the third consecutive meeting this week is expected to maintain policy stability, Fed Chairman Powell and his colleagues will use a “bitmap” to predict the path of interest rate cuts in 2024, although interest rate cuts may not be as large as investors and economists expect.
If the Fed lowers interest rates while inflation cools, this is good news for both the economy and investors, because it means the Fed is about to achieve an elusive soft landing, that is, inflation will fall back to pre-pandemic levels, and the economy will not fall into a slump.
But if the Fed cuts interest rates because the economy is rapidly deteriorating, facing a risk of recession, or falling into recession, then it is a different story. This will indicate that the unemployment rate will rise significantly, and that as demand falls, corporate profits will be hit.
“Investors want interest rate cuts because the economy and inflation have cooled down, not because the economy is in recession,” said Diane Swonk, chief economist at KPMG.
The Fed's motivation to cut interest rates will affect the extent of interest rate cuts. Economists say that if the economy falls into recession or is at risk of recession, officials may quickly and drastically relax policies. But without a serious recession, the pace of interest rate cuts may be smaller and slower.
How Fed Chairman Powell manages monetary policy shifts is important to US President Joe Biden. Voters are already dissatisfied with Biden's way of handling the economy due to soaring living costs. If the US falls into recession, Biden will face greater resistance in seeking re-election.
The November non-farm payroll report released on Friday showed little sign that the economy was about to contract. The unemployment rate fell to 3.7% from 3.9% in October, and wage growth remained steady. Biden later commented that the non-farm payroll report did not encourage the Fed to resume raising interest rates.
Money market traders lowered their expectations for interest rate cuts after employment data was stronger than expected. They now think the possibility that the Fed will cut interest rates for the first time in March next year is less than 50%, and they expect the cumulative rate cut in 2024 to be slightly higher than 100 basis points. In contrast, earlier this month, traders expected the probability of interest rate cuts starting in March to be about 60%, and expected interest rate cuts for the full year of 2024 to reach about 125 basis points.
Economists' expectations of the Fed's interest rate cut
Current market pricing is more in line with economists' predictions. Federal Reserve observers surveyed by Bloomberg last week expect the Fed to cut interest rates by 100 basis points next year, and that the first rate cut will come in June.
More than two-thirds of respondents expect the economy to avoid recession in 2024. Nearly three-quarters of economists said that the initial interest rate cut would be to deal with falling inflation rather than economic contraction.
The survey showed that when the Fed, which is cautious about inflation, releases a summary of economic forecasts this week, its forecast for interest rate cuts will be much more conservative than the market. According to a survey of 49 economists from December 1 to 6, it is expected that the “bitmap” announced by Powell and his colleagues after the meeting will show that next year's interest rate cut will be only 50 basis points.
Brett Ryan, senior US economist at Deutsche Bank, said, “We don't expect the 'bitmap” to suggest interest rate cuts in the first half of next year. '
BI strategists Ira F. Jersey and Will Hoffman said, “If the Fed reaffirms that it will keep interest rates at their peak for a long time next year, then the interest rate market, which is expected to cut interest rates sharply in early 2024, may be impacted this week.”
Powell said on December 1 that it was “too early” to speculate when the Fed might relax its policy, and even reserved the possibility of raising interest rates further if necessary to curb inflation.
Joseph Lavorgna, the US chief economist at SMBC Nikko Securities, pointed out that in the past five tightening cycles of the Federal Reserve, the average time from the last rate hike to the first rate cut was 8 months. The last time the Fed raised interest rates was in July, which means that interest rates may be cut in March.
Lavorgna said, “There is still a high possibility of interest rate cuts in March. There will be 3 more employment reports from now until then.” The worsening labor market and weak inflation will prompt the Fed to take action.
Lavorgna, who held key positions during the Trump administration, said that the November presidential election also made the Fed tend to act early next year to try to avoid political attention.
Lavorgna expects the Fed to cut interest rates by 125 basis points next year, and is likely to cut interest rates even more. He added that this will not be enough to stop the recession, but it will limit the damage to the economy.
In contrast, Michael Gapen, chief US economist at Bank of America, expects the economy to avoid recession, the Fed will cut interest rates by 75 basis points in 2024, and the first rate cut will take place in June. He said that the decision to cut interest rates will be a response to reduced price pressure rather than a shrinking economy.
Stifel Financial Corp., chief economist Lindsey Piegza, believes, “There is a lot of resistance and uncertainty on the path of inflation, and the Fed cannot completely release the brakes.”
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