Payden & Rygel: US Fed Policy Path - Inflection Point?

Payden & Rygel: US Fed Policy Path - Inflection Point?

November 11, 2024

Fed
Fed dollar (kreatikar, Pixabay)

By Jeffrey Cleveland, Chief Economist, Payden & Rygel

We’re often at odds with bond market pricing for the Fed’s policy path. Historically, such situations signaled turning points for rates. Is there another interesting inflection point before our eyes?

As we expected, the Fed delivered another 25 basis point cut at the November FOMC meeting. Will the Fed keep cutting, and how quickly? These might be the most critical questions for the year ahead. 

We think the Fed will cut another 25 bps in December, bringing the midpoint year-end policy rate to 4.375%. However, we expect the Fed to slow the pace of rate cuts in 2025, going once per quarter rather than at every meeting. But not for reasons you might suspect. 

A common (we would say way-too-consensus view) is that a re-acceleration in inflation will spoil the Fed’s cutting plans. As we’ve covered elsewhere, we doubt the incoming President’s fiscal plans will fan inflation flames, at least in the short term. Incidentally, Powell asserted that “the election will have no effects on our [the Fed’s] policy decisions”—at least until new economic policy laws are enacted. And even then, it will require policymaker judgment to gauge the likely impacts in light of other data cross-currents to determine the appropriate policy response. A knee-jerk reaction with higher rates may not be justified. 

So, where do we see rates going? We remain upbeat on growth. Powell reiterated during the Q&A portion of today’s festivities that he would not welcome further deterioration in the labor market, meaning the Fed will keep removing restrictive policy. However, solid economic data may slow the descent toward 3.5%-3.0% (our current estimate of the Fed’s “neutral”). A more dire economic slowdown would warrant a quicker cutting cycle, which we do not yet foresee. 

Is there a case for inflation to cool more rapidly and for the Fed to cut faster than we expect without involving a growth slump? Yes! Crazy as it seems, inflation could cool more rapidly than we expect, opening the door to a quicker return to neutral. Our 2025 core PCE forecast path shows the Fed’s favorite inflation gauge reaching 2% by mid-year. Recall that the Fed’s focus now is on “removing restriction” to foster full employment, so as inflation cools, the Fed could keep cutting even in the face of solid economic growth data.

Interestingly, we find ourselves in a rare position. For much of the last three years, we have almost exclusively been more hawkish than the bond market; we’ve forecasted more rate hikes than were priced in, a longer time on hold than the market anticipated, and a slower pace of cuts once they eventually began. We feel vindicated in our views, but now we see that the bond market is more hawkish than our expected Fed path (see Figure 1, Top Panel)! 

Alas, this has happened before and was a counter-indicator for rates. The lesson: when the market is more hawkish than the Payden Economics Team, rates may have hit a near-term yield peak. When the market is too dovish, rates may have room to rise

 

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