As the Federal Reserve prepares for its next policy meeting on September 18, the financial markets and economists alike are bracing for what many anticipate will be the first of several interest rate cuts. According to a recent Reuters poll, the consensus among economists is that the Fed will initiate a 25 basis point cut next week, with additional cuts likely to follow at each of the U.S. central bank's two remaining meetings this year.
The forecast comes amid a backdrop of easing inflation and signs of an economic slowdown, which have prompted Fed officials to reconsider their aggressive rate-hiking strategy. The federal funds rate, which has been held in the 5.25%-5.50% range since July 2023, is now expected to be gradually reduced as part of a broader effort to maintain economic stability.
In the Reuters poll conducted from September 6-10, a strong majority of 92 out of 101 economists predicted a 25-basis-point cut at the upcoming meeting. The sentiment among experts is that the Fed is likely to adopt a cautious approach, given the mixed economic signals. Stephen Stanley, chief U.S. economist at Santander, noted, "The employment report was soft but not disastrous... Both Williams and Waller [Fed officials] offered a relatively benign assessment of the economy, which points strongly, in my view, to a 25-basis-point cut."
This anticipated rate reduction would mark the beginning of a gradual easing cycle, with two additional cuts of 25 basis points each expected in November and December. This prediction is supported by 65 out of 95 economists surveyed, up from 55 in the previous month.
The backdrop to this shift in monetary policy is a mixed economic landscape. The U.S. economy grew at an annualized pace of 3.0% in the second quarter, and the unemployment rate remains low, hovering around 4.2%. However, inflation, which had been a significant concern, has moderated significantly. The Fed's preferred measure of inflation, the Personal Consumption Expenditures (PCE) price index, fell to 2.5% in July, down from a peak of 7.1% in June 2022.
Despite these positive signs, there are underlying concerns about the sustainability of economic growth. Employment growth, which averaged 250,000 new nonfarm payroll jobs per month in 2023, is showing signs of slowing, and job openings have declined. This has shifted the Fed's focus from solely taming inflation to also addressing potential weaknesses in the labor market.
The upcoming inflation reports-Consumer Price Index (CPI) on Wednesday and Producer Price Index (PPI) on Thursday-will be crucial in shaping the Fed's decision. Veronica Clark, an economist at Citigroup, emphasized, "Inflation data has taken a backseat to labor market data in terms of influence on Fed policy... but August CPI data could remain an important factor in the upcoming decision."
While the Dow Jones consensus forecast predicts a 0.2% increase in the CPI for August, translating to annual inflation rates of 2.6% for the all-items measure and 3.2% for the core, these figures are still above the Fed's long-term target of 2%. However, the downward trend in inflation and the Fed's growing concerns over the labor market suggest that the central bank is leaning towards a rate cut.
As the Fed gears up for its September meeting, market expectations are largely aligned with a quarter-point rate cut, with futures market pricing indicating a 71% likelihood of such a move. However, some economists argue that the Fed might be underestimating the need for more aggressive action. Samuel Tombs, chief U.S. economist at Pantheon Macroeconomics, expressed concern that the Fed's cautious approach might not be sufficient to address the slowing labor market, stating, "We're disappointed - but not surprised - that FOMC members are still leaning towards a 25 [basis point] easing this month... but by November, with two more employment reports in hand, the case for rapid rate cuts will be overwhelming."
