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Takeaways from the start of a Fed rate-cutting cycle

Investing.com — The Federal Reserve initiated its rate-cutting cycle in September, delivering an aggressive 50 basis-point (bp) reduction to policy rates. The decision marked a significant shift in monetary policy as this was the first rate cut in the US since 2020.

According to Wells Fargo, the size of the cut, alongside Fed chair Jerome Powell’s commentary, signaled some concern over the state or direction of the job market and less concern regarding inflation.

“Powell indicated during his press conference that the labor market was in a strong place, and the Fed’s rate decision was intended to keep it there,” Wells Fargo strategists said in a recent note.

Federal Open Market Committee (FOMC) members expect unemployment to rise slightly, to 4.4% for 2024 and 2025, while GDP growth is projected at 2.0% annually during the same period.

According to Wells Fargo, this suggests that the “labor market that is cooling, but not considerably.”

“Notably, the FOMC members also see inflation continuing to decline. We believe this base scenario sets the stage for rate cuts but leaves their magnitude in question, especially for the implied rate cuts in 2025,” they added.

However, the Fed’s updated projections differ from market expectations. According to the report, the market is pricing in 125 bps of rate cuts for both 2024 and 2025, which is more aggressive than the Fed’s median projection of 100 bps of cuts in each year.

“With all but one FOMC participant seeing 100 bps or less of cuts in 2024, the market may be in for some disappointment,” strategists continued.

“Market pricing would require at least one additional 50 bps cut in 2024 instead of two 25 bps cuts, which we do not believe is supported by the current state of the labor market. Also, judging by commentary from Powell, we do not believe the Fed sees that outcome either.”

Looking ahead, strategists remain cautious about the market’s expectations for the Fed’s rate-cutting cycle, considering them “too optimistic.” They suggest that a total of 200 bps of cuts through 2025 would likely require a notably worse economic environment than either their own or the Fed’s current projections.

“If the economy continues to move toward a gradual slowdown followed by a recovery in the second half of 2025, as we expect, we believe the cut in September will probably be the only 50 bp rate cut we see in this cycle,” the note states.

Also, Wells Fargo believes inflation could potentially resurge by mid-2025, which could limit the Fed’s ability to implement all the rate cuts it has projected.

In their view, a more realistic scenario would see an additional 50 bps of cuts in 2024 and 75 bps in 2025.

This post appeared first on investing.com

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