Since inflation in the U.S. is falling and worries that the economy is getting too hot are subsiding, experts are pretty sure that the Federal Reserve will lower its key interest rate for the first time this cycle in September.
It’s not clear what will happen next.
Diane Swonk, chief economist at KPMG Economics, said, “The ground is rough, and the Fed is walking a tightrope.”
The Fed has kept its policy rate steady at between 5.25% and 5.5% for the past year.
That’s a lot higher than the nearly 3% rate that’s considered “neutral.” The central bank kept policy rates high to slow down demand and keep inflation low.
Fed officials haven’t even started to talk about what they think about the longer-term cycle of monetary easing.
Economists have split into two main groups when they are left to their own ways.
The Fed cutting rates by 75 or 100 basis points before stopping is seen as a “recalibration.”
The other group believes that the Federal Reserve will stop raising rates after the first one and then set up a series of rate cuts that will bring the average interest rate down to a level close to 3%.
Traders in derivatives markets are in the second group.
They have put in rate cuts of 175 basis points, which will bring rates down to a range of 3.5% to 3.75% by summer of next year.
Some experts think that makes them think of January, when markets thought that rates would go down six times in 2023.
“We think the markets are back to being too optimistic about the next rate cycle,” wrote Michael Gapen in a note to clients as head of U.S. economics at BofA Securities.
According to the Fed, the rate of cuts will happen more slowly.
New “dot-plot” predictions show that rates will be lowered one time in 2023 and then four times in 2024, which is about once every three months.
Stephen Brown, who is the deputy chief North America economist at Capital Economics, thinks that the Fed will cut rates in September, skip November, and then start cutting rates steadily again in December. They will keep doing this until rates are between 3.5% and 3.75% next summer.
Brown doesn’t think that his prediction means the Fed is cutting rates. “This view is based on the idea that we’re getting closer to a normal economic situation, which means that you don’t need stringent policies,” he said.
“An increase of 25 basis points at each meeting would still be a slow process.” “An emergency rate would be at least 50 basis points at every meeting,” Brown said.
Matthew Luzzetti, who is the top U.S. economist at Deutsche Bank, thinks that the first 25 basis point cut will happen in September. There will then be two more cuts in November and December. The Fed would not do anything else until September 2025.
Luzzetti pointed out that this is similar to the “mid-cycle adjustments” the Fed made in the early 1990s and in 2019, two times when the central bank wasn’t trying to fight a recession.
For the Fed to start cutting more, he said, the job market would have to get worse first.
On both groups, everyone agrees that the new president’s fiscal policies could change the policy path next year.
The Federal Reserve will meet next week, and rates are likely to stay the same.
In a note to clients, experts at Oxford Economics said that they think they will use the meeting to “plant the seed that the first move” is possible in September.
