Updating Interest Rate Forecasts After Fed Meeting, Weak Economic Data

In this article we review: 

• Our updated interest rate forecasts for year-end 2024 and 2025
• Weak economic data likely conveying a greater sense of urgency for the Fed to reduce rates 
• Why we believe the Federal Reserve has now shifted its focus from inflation to employment
• How the current real rate of interest could impact Fed policy actions

The central focus of Fed policy and future rate cuts, both in terms of timing and magnitude, has, in our view, now shifted from one of inflation to that of potential economic slowing. In recognition of this, we are adjusting our interest rate forecasts. We now see the Federal Reserve likely to conclude CY 2024 with a federal funds target range of 4.50–4.75%. This would represent consecutive quarter-point rate cuts at each of the next three meetings, potentially followed by four quarter-point rate cuts in CY 2025, concluding next year at a target range of 3.50–3.75%. As the Treasury bond yield curve ultimately reverts to an upward slope, we now believe a realistic expectation for the 10-year Treasury yield to be 3.75% for both year-end 2024 and 2025.

Additional key points for investors to consider include:

Recent economic data highly supports the case for Fed rate cuts. The case for faster and more substantial fed rate cuts was bolstered by the July nonfarm payrolls report released on August 2 estimating only 114,000 new jobs added to the economy, which compares unfavorably to the 12-month average of almost twice that amount. In addition, the June jobs report was revised downward (206,000 to 179,000) and the unemployment rate rose to 4.3% for July, its highest level in almost three years. This employment data followed the August 1 Institute of Supply Management’s Purchasing Managers Index report, which also came in below expectations (46.8 vs 48.8).

Fed conveys a dovish tone after August 1 meeting. While the Fed kept the fed funds target range unchanged at 5.25%–5.50%, revised language in its official statement appeared to lean decidedly toward a rate cut in September. In his commentary during the post-meeting press conference, Chair Jay Powell also said, “A reduction in our policy rate could be on the table as early as September.” In our view, the Fed has set up a high probability of a quarter-point rate cut at its upcoming September meeting, which we now believe will be followed by additional rate reductions to finish out the year and throughout 2025.    

Declining inflation now contributes to an overly restrictive real rate of interest. With personal consumption expenditures (PCE) core inflation most recently posting a year-over-year rate of 2.6%, the real rate of interest (upper bound fed funds rate minus core inflation) is now at 2.9% (5.5% minus 2.6%). This is now the highest and most restrictive level this rate has been since 2007. We believe given recent weakening data, the Fed will act accordingly in the months ahead to reduce this rate to help fend off the risk of economic contraction. 

The Fed has nothing left to wait for. The Fed last raised rates more than a year ago, and since that time core inflation has declined considerably (as seen in the average rate of consumer price index core and PCE core inflation having fallen from 4.5% to less than 3.0%). Given this backdrop combined with weakening overall economic data, it now appears an increased focus on the other side of the Fed’s dual mandate (maximizing employment) will soon be in action. We therefore see a faster pace of rate cuts soon to be implemented and an eventual shift in the yield curve to an upward slope. 

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