The Federal Reserve has made it official: The aggressive interest rate hikes of the past 18 months have mostly tamed the inflationary storm that caught policymakers off guard in the wake of the pandemic, while the labor market has largely shrugged off the consistent recession predictions from Wall Street, and GDP continues to expand.
Even Fed Chair Jerome Powell isn’t dampening the mood of Wall Street bulls, some of whom, after two surprisingly positive inflation reports, now say there’s an “immaculate disinflation” underway. On Wednesday, Powell touted the immense “progress” taming inflation and declared the Fed at or near the peak rate for this cycle in a dovish tone that was music to the ears of Wall Street.
And the Fed’s latest economic outlook, which projects three rate cuts over the course of next year, has given Wall Street’s top minds a new topic for debate: When, exactly, will the Fed begin cutting rates—and by how much?
The answer to that question will be critical in determining the staying power of the stock market’s recent rally, and the health of the economy in 2024. If the Fed is forced to cut rates rapidly next year, it’s likely a sign that the economy has moved from cooling to freezing, and central bank officials are attempting to warm it up. But if the Fed can gradually lower interest rates throughout 2024, they may end up getting the soft landing they’ve been hoping for—where inflation returns to the 2% target rate without significant job losses.
View this interactive chart on Fortune.com
Rate cuts are coming, but when?
To figure out when and how much the Fed will cut rates, it helps to understand what the Fed’s ultimate goal—the neutral rate of interest—is for the current economy. In Wolters Kluwer’s December Blue Chip Economic Indicators survey, which polls economists from major investment banks, research firms, and Fortune 500 companies, respondents put the neutral Fed funds rate at just 2.6%, less than half of its current level of 5.3%.
The neutral rate of interest, also known as r*, is the Fed funds rate that would be neither contractionary or expansionary for the economy, in other words, neither slowing it down nor artificially stimulating it. That’s assuming the U.S. is at full employment and has reached stable inflation (i.e., when the Fed has fulfilled its dual mandate).
How will we get there?
Well, the timing and depth of interest rate cuts are still being debated. And the answers depend on what happens with the economy in the next few months. Will unemployment surge unexpectedly? Will U.S. consumers tighten their belts?
Some 17% of respondents said they expect the first rate cut in the first quarter of 2024, but another 40% don’t expect a cut until the second quarter. The biggest investment banks and wealth managers have pretty divergent views on just how far and how fast Chair Powell will cut rates next year. Here are their best guesses.
View this interactive chart on Fortune.com
Wall Street’s predictions
Goldman Sachs
Goldman Sachs’ chief U.S. economist, David Mericle, has shifted the timing of his interest rate cut forecast for next year after the good news from the latest inflation readings and Fed comments, he explained in a Thursday note.
“In light of the faster return to target [inflation], we now expect the FOMC [Federal Open Market Committee] to cut earlier and faster,” he wrote, predicting three consecutive 25 basis point rate cuts in March, May, and June. However, Mericle said that he is “quite uncertain about the pace” of rate cuts still, arguing “it will depend on how financial conditions respond.”
UBS Global Wealth Management
Solita Marcelli, chief investment officer of the Americas at UBS Global Wealth Management, thinks investors are too optimistic. She argued Thursday that the market is pricing in “too fast a pace of cuts.”
“We think the experience of this rate cycle is that it pays to listen to the Fed. Our base case forecasts the Fed will refrain from further rate hikes and will start trimming rates by the middle of 2024,” she wrote, arguing the Fed will cut rates by 75 basis points in the second half of next year.
Citi
Citi’s chief U.S. economist, Andrew Hollenhorst, who has long warned about a potential economic downturn, said Wednesday that he believes the Fed is seeing the same bad omens he is. He attributed the central bank’s dovish stance this week to “growing concerns that a recession will ensue without an easing in financial conditions.”
Hollenhorst expects the Fed to cut rates by 25 basis points in July, followed by an additional 75 basis points of further cuts by year-end 2024. “But the dovish meeting increases the risks of earlier and/or more cuts,” he wrote in a note to clients.
Wells Fargo
Scott Wren, senior global strategist at Wells Fargo, believes investors and the Fed are pricing in too many interest rate cuts for 2024, even though inflation is fading.
“By the end of next year, the market is pricing in around 125 basis points of cuts. That is overly optimistic, in our opinion,” he wrote in a Wednesday note.
Wren believes the Fed funds rate will end 2024 in a range between 4.75% and 5%, slightly above the central bank’s 4.6% projection.
Bank of America
Bank of America’s chief U.S. economist, Michael Gapen, correctly predicted that the Fed would forecast three rate cuts at the December FOMC meeting. And like the Fed, he believes multiple rate cuts are on the way over the coming years.
“Upcoming Fed decisions will likely be more about how long to maintain its current policy stance than whether additional policy rate firming is needed,” he explained in a Monday note to clients.
However, while Gapen expects the Fed funds rate will drop to 4.6% in 2024 and 3.6% in 2025, he believes it will then jump back to 3.9% in 2026.
Morgan Stanley
Morgan Stanley’s chief U.S. economist, Ellen Zentner, said Thursday that she doesn’t expect the Fed to start cutting interest rates until June, arguing that progress in taming inflation will slow in the coming months.
“With the focus no longer on ‘how high?’ the FOMC has turned to talking about when to cut. As 2024 moves into focus, they've sharpened their views. We and they expect real rates will fall next year. But we expect that inflation progress stalls in 1Q, holding off the first cut,” she wrote in a note to clients.
