Overview
What happened
In what was a hotly contested meeting, with markets split between a 25 versus 50 basis point start to the cutting cycle, the Federal Reserve ended up going big, cutting rates by 50bp. This was more than we and consensus expected but ultimately broadly in line with market pricing, which had moved more clearly in favour of a larger cut following leaks in the Wall Street Journal over the past few days.
The vote was 11-1, with Board of Governors member Michelle Bowman as the first governor dissenting since 2005, voting for a smaller 25bp cut. Fed Chair Jerome Powell's statements during the press conference, however, suggest that the discussion was a lot closer to 50/50 than this vote suggests. The market reaction since the presser suggests that this was somewhat of a “buy the rumour, sell the news” event, with yields slightly higher and equities marginally lower.
Our interpretation
The Fed is now clearly focused almost entirely on the labour market and the press conference strongly suggests to us that downward revisions to non-farm payrolls following the Quarterly Census of Employment and Wages revisions and the two weak job reports over the summer pushed the “several” members who were ready to cut in July to lobby for 50bp today to catch up. Powell seems to be clearly in that camp.
However, risks are still seen as balanced, and the economic projections remain very positive, including a low and falling unemployment rate over the forecast horizon. Growth is seen at above the long-run potential throughout the forecast period while inflation is forecast to return to target. In fact, the summary of economic projections could not paint more of a "job done" view of the world, which appears more goldilocks than soft landing.
The dots that show all Federal Open Market Committee (FOMC) participants’ projections of future interest rates remain higher than market pricing, but we'd expect rates markets to largely ignore the dot plot and push the Fed towards quicker or stronger easing now that the Pandora's box of larger than 25bp cuts is open. There's 50bp more easing in the median dot for 2024, but it's a narrow majority of 10-9 in favour of 50bp vs 25bp, so the mean dot is higher. Including next year's 100bp in the dots, the Fed is looking for another six "normal" 25bp cuts, versus market pricing of around eight by the end of next year. For the rest of this year, markets are now pricing around 34bp for November and 70bp by year-end, almost twice as much as the mean dots suggest.
Our outlook
With those projections and balanced risks we don't really see the case for additional 50bp cuts, but two more cuts of 25bp this year are clearly on the table. We broadly agree with market pricing of a terminal range of around 3 per cent, but the pace of cuts being priced still looks too fast to us given the healthy and clearly less rates-sensitive state of the economy and risks around election outcomes.
The focus will now be on the job reports for September and October, which we get ahead of the November FOMC meeting. A further slowing of job growth and a rising unemployment rate would most likely see markets push the Fed towards another 50bp cut in November.
We continue to see a soft landing as the base case but labour market developments over the coming months will determine the direction of travel including pace and magnitude of cuts. We don't expect a more significant labour market deterioration in the near term given strong fundamentals and resilient growth, which keeps us on the somewhat hawkish side of market expectations. However, we will continue to assess our views as labour market data and election results come through.
