The Federal Reserve has penciled in 75 basis points of rate cuts for next year, only mildly pushing back against market expectations of 1.25 percentage points of easing. Fed chair Jerome Powell said an additional rate hike is still "on the table" but unlikely. The S&P 500 rallied strongly.
"Inflation keeps coming down. The labor market keeps coming into balance. So far so good," Powell said. While the Fed continues to expect their job will get harder, "so far it hasn't," he said.
In fact, the Fed projections and Powell's remarks were so well received that markets were pricing in 1.5 percentage points of rate cuts by the time Powell wrapped up his news conference at 3:15 p.m. ET.
Federal Reserve Meeting Policy Statement
Recent Fed meeting policy statements have said that policymakers will continue to assess "the extent of additional policy firming that may be appropriate" to bring inflation down to 2%.
On Wednesday, the Fed largely reiterated that language, signaling that rate cuts aren't yet being considered. But the Fed added the word "any" before "additional policy firming." Powell said a rate hike is "on the table," but policymakers are "thinking we have done enough."
Powell added that the Fed is also assessing how long it needs to keep policy restrictive.
The Fed did note that inflation has eased "but remains elevated."
Fed Quarterly Economic Projections
The new batch of quarterly projections shows that Fed committee members expect to cut their key policy rate to 4.6% by the end of 2024, down from the current range of 5.25% to 5.5%. September projections showed the federal funds rate ending next year at 5.1%.
Of 19 committee members, 11 forecast a year-end 2024 policy rate of no more than 4.625%, implying a range of 4.5% to 4.7%. Eight other members think the Fed will need to hold its policy rate at least a quarter-point higher.
Fed policymakers trimmed their forecast for GDP growth in 2024 to 1.3% from 1.4% in September. Core PCE inflation is now seen falling to 2.4% next year vs. the prior projection of 2.6%.
For 2025, policymakers now see a year-end policy rate of 3.6%, down from September's 3.9% forecast. A further cut to 2.9% is forecast for 2026, unchanged from September.
Fed policymakers left their estimate of the long-term neutral policy rate unchanged at 2.5%. The Fed's estimate of the neutral rate has been unchanged since 2019. That implies that the Fed still thinks that the low interest rates that prevailed before the pandemic will continue, despite economic shifts tied to trade friction, the green energy transition, the aging population, generative AI progress and rising federal debt.
Fed Chair Powell
Powell highlighted the major drop in inflation expectations for 2023. Policymakers now see core PCE inflation ending this year at 3.2%, down from September's 3.7% projection.
"If you look at the six-month measures, you see very low inflation," Powell said.
But he's not taking further progress for granted, noting a recent history of economic growth surprising on the upside. "If we see stronger growth, we will set policy according to what we actually see."
"We're getting back to the point where both mandates are important," Powell said, referring to the Fed's 2% inflation and full employment mandates. He said the Fed is very cognizant of the risk of keeping policy tight for too long.
Powell sounded upbeat about the economy, noting that growth has come down and the tight job market had eased without much of a rise in unemployment. Policymakers continue to see the unemployment rate rising to 4.1% at the end of 2024.
On more of a mixed note, Powell highlighted uncertainty about whether the neutral interest rate is higher than it was last decade. If it has climbed, interest rates might not fall as far, he said.
Fed Rate-Cut Odds
Ahead of the 2 p.m. release of the Fed's economic projections, markets were pricing in 47% odds of a quarter-point rate cut by the March 20 meeting. Markets saw 78% odds that the Fed's first rate cut will happen by the May 1 meeting. For all of 2024, markets saw slightly-better-than-even odds (54%) of five quarter-point cuts.
After the releases, odds of a March rate cut jumped to 78%. Odds of 1.25 percentage points in rate cuts next year reached 90%. Actually, markets now see above-even odds (70%) of 1.5 percentage points in cuts. That would lower the federal funds rate to a range of 3.75% to 4%.
S&P 500 Reaction
The S&P 500 rose 1.4%, continuing to move higher as Powell spoke. The S&P 500 has racked up five straight gains, including four 52-week highs. By Wednesday's close, the S&P 500 had rallied more than 14% since Oct. 27.
The 10-year Treasury yield dived 17 basis points to 4.03%.
Markets are betting that what some call "immaculate disinflation" will continue, allowing inflation to fall to the Fed's 2% target without a real hit to the economy. For now, the Fed doesn't seem too worried that the wealth effect from higher stock prices and an economic boost from lower interest rates will give consumers a second wind, keeping inflation above target.
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