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Thoughts of the Week - June 7th

Game On! All eyes will be watching the start of this week’s best of seven game series between the Eastern and Western conference winners to bring home a basketball championship. The contenders: one of the oldest franchises in basketball history (Boston) and a serious challenger (Dallas) that has the potential to upset Boston’s chance to become the most winning team in League history (currently tied with Los Angeles’ 17 title wins). And with recent economic data showing signs of softening, all eyes will be on the FOMC meeting next week too—particularly as policymakers provide updated economic projections, a new dot plot and Chair Powell has a post-meeting press conference. Nearly one year after the Fed last raised rates (July 2023), the market is on watch for when the Fed’s easing cycle will begin.




Fed to Update Their Key Projections

Fed To Update Their Key Projections | Fed officials have spent the last six weeks walking back Powell’s dovish stance at his press conference following the last FOMC meeting (May 1). We expect the Fed to hold the fed funds rate steady for the 7th consecutive meeting (June 12) as policymakers delay rate cuts while inflation remains stubbornly above their 2.0% target. Below is a summary of what to expect at the FOMC meeting next week:


Economic Growth

Fed officials upgraded their 2024 growth estimate from 1.4% to 2.1% at the March meeting and maintained above-trend projections for 2025 (+2.0%) and 2026 (+2.0%). The data released since the last FOMC meeting (May 1) has seen a downward revision to Q1 GDP (from 1.6% to 1.3%), softer consumer spending (including a retail sales miss) and anecdotal reports of businesses needing to offer incentives to spur sales. While growth should moderate in the coming quarters, a soft, non-recessionary landing remains the Fed’s (and our) base case. The Fed’s updated growth projections should not move much from their current level and remain near potential in a 1.9% to 2.1% range.


Inflation

In March, the Fed projected that inflation (as measured by the core PCE price index) would slowly decline from 2.6% in 2024 to 2.0% by 2026. While disappointing inflation readings over the last few months may have shaken Fed officials’ confidence, the pendulum is swinging back the other way. With growth slowing and the labor market moving into balance, the threat of reaccelerating inflation has diminished. And with oil prices at a four-month low, consumers pushing back on price increases, retailers slashing prices, and restaurants rolling out value meals—the disinflationary trend should resume. We do not expect any major shifts to the Fed’s inflation projections as recent developments suggest the disinflationary trend is intact.


Federal Funds Rate

The March dot plot showed a gradual reduction in the fed funds rate, with the median projection of 4.6% in 2024 (the equivalent of three 25 bps rate cuts), 3.9% in 2025 and 3.1% in 2026. Policymakers do not appear to be in a rush to cut rates, particularly as growth and the labor market remain healthy. Given there are only 5 meetings between now and the end of the year, we would not be surprised by a minor shift in the median dot, with possibly one rate cut shifting into 2025. This should not have a big impact on the market as expectations have already shifted in this direction—the market is pricing in fewer than 2 cuts this year. We remain on the fence with 2 to 3 rate cuts this year. Perhaps, most important, will be the Fed’s longerrun fed fund projection (the neutral level—a level that neither slows or stimulates growth), as some policymakers question how restrictive monetary policy is right now. Our best guess is the longer-run median dot moves a touch higher.


Powell's Press Conference

The most anticipated part of the FOMC meeting will be Powell’s press conference. While Powell recently suggested that he was less confident that inflation was moving in the right direction, softer economic and more benign inflation data should ease his concerns. The press conference will provide him with an opportunity to clarify the Fed’s new forecasts. With few changes expected, Powell will likely get peppered with questions about the exact timing of the first rate cut, the labor market outlook and the current degree of policy restrictiveness.


Bottom Line

While the odds of a July rate cut are less than 10%, the market may be underestimating the Fed. With economic data rolling over, inflation resuming its downward trend, and plenty of important data releases (2 PCE, 2 CPI and 1 payroll report) ahead of the next FOMC meeting (July 30-31)—which is still seven weeks away—policymakers still have ample time to assess the state of the economy and need to begin easing rates. Our economist expects that economic conditions will warrant 2 to 3 cuts this year, starting as early as July (more likely September). These cuts will be ‘insurance cuts’ to help the economy avert a recession.


Chart of the Week

Fed Rate Cut Expectations Have Been On A Wild Ride! Market expectations for the number of Fed rate cuts in 2024 have seen massive swings since the Fed’s last rate hike in July 2023— moving from six to fewer than three, then back to over six and most recently expecting just over one rate cut this year.



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