Fed June-24 quarter projections gets realistic on inflation and rates

17 Jun 2024 , 12:41 PM

FED QUARTERLY PROJECTIONS UPS PCE INFLATION AND RATE OUTLOOK

Along with the Fed policy statement on June 12, 2024, the Fed also updated its quarterly projections of key macros. The Federal Open Markets Committee (FOMC) gives a quarterly update of key projected macros, which includes GDP growth, core PCE inflation, headline PCE inflation and unemployment. All these are the building blocks and they eventually go into the Fed trajectory for interest rates at the end of the next 3 years and also for the long run. It is the rate guidance and the inflation guidance that the markets lap up with a lot of interest. The big change in June 2024 update was that the Fed is pencilling in higher than expected core PCE inflation and headline PCE inflation for 2024 and 2025. As a result, the interest rates trajectory is likely to remain at elevated levels for longer.

In March, the Fed had diligently upped its GDP estimates, but this time that is static. It is not surprising considering the GDP growth has been progressively under pressure in the last 3 quarters, with the Q1 GDP growth estimates coming in closer to 1.3%. So, growth remains constant, but the projections of unemployment are higher for 2025 and forward. Secondly, the Fed has upped the core PCE inflation projections as well as the headline PCE inflation projections by 20 bps for calendar 2024. In addition, there is a 10 bps hike in 2025 estimates also. That is not surprising since the Fed has struggled with last mile inflation in the last few months, especially since the Red Sea crisis has proved to be the thorn in the flesh for Fed. As a result, the Fed is expecting the rates to stay higher for longer. More on that later!

SNEAK PEEK AT THE US MACRO STORY FOR LAST 5 YEARS

Here is a quick recap of the data points of the last 5 years. These are actuals and based on actual data flows. It has been updated for actual 2023 data also.

Variable	CY-2019	CY-2020	CY-2021	CY-2022	CY-2023
Real GDP Growth	3.2%	-1.1%	5.4%	0.7%	3.1%
Unemployment Rate	3.6%	6.7%	4.2%	3.6%	3.8%
PCE Inflation	1.4%	1.2%	5.9%	5.9%	2.8%
Core PCE Inflation	1.5%	1.4%	4.9%	5.1%	3.2%

Data Source: US Federal Reserve (CY refers to calendar year)

Here are some of our key takeaways from the macros of the last 5 calendar year up to the end of 2023. Let us start with the real GDP first. GDP had been consistently over 3% till 2019. We will have to ignore the period between 2020 and 2021 as it was a sharp fall followed by a sharp recover. It overstated on either side. However, from CY2022 onwards, a clearer trend was visible. In CY2022, the real GDP was low at 0.7% primarily due to the elevated levels of inflation. In CY2023, the boost to US GDP came largely from a sharp fall in PCE inflation, even though nominal GDP was approximately at the same level. The low employment ratio is on the back of demand for workers sharply higher than supply. On the inflation front, the series of rate hikes by the Fed is having an impact. After averaging 5.9% in 2021 and 2022, the headline PCE inflation has more than halved to 2.8% in calendar 2023. The core PCE inflation has also fallen in tandem with the headline PCE inflation in CY2023.

RECAP – MARCH 2024 FOMC PROJECTIONS (VERSUS DECEMBER 2023)

Each quarter, along with the nearest Fed policy statement, the Federal Reserve also puts out the consensus estimates of key economic variables for the next 3 calendar years and for the long run. To get a context, we will start with the background of what happened in the March 2024 projections, compared to the December 2023 projections on each of these variables. The outcomes are captured in the table below; and for each variable and for each year, the March 2024 projection is also accompanied with the previous December 2023 projection.

Variable	CY-2024	CY-2025	CY-2026	Longer run
Change in real GDP (Mar-24)	2.10	2.00	2.00	1.80
December projection	1.40	1.80	1.90	1.80
Unemployment rate (Mar-24)	4.00	4.10	4.00	4.10
December projection	4.10	4.10	4.10	4.10
PCE inflation (Mar-24)	2.40	2.20	2.00	2.00
December projection	2.40	2.10	2.00	2.00
Core PCE inflation (Mar-24)	2.60	2.20	2.00
December projection	2.40	2.20	2.00
Federal funds rate (Mar-24)	4.60	3.90	3.10	2.60
December projection	4.60	3.60	2.90	2.50

Data Source: US Federal Reserve (CY refers to calendar year)

Here are some of the key takeaways from the FOMC long term projections for the March 2024 quarter, pertaining to the likely guidance on macros for next few years.

• Let us first talk about the real GDP (nominal GDP net of inflation) growth projected for the coming years in March 2024. For CY2024, the real GDP was expected to grow by 2.1%. This is likely to be largely helped by lower retail inflation. The CY2024 projection of GDP is a good 70 bps above the December projections and is in sync with the rising optimism of the Fed members on the growth front. Further upsides may be limited.
• Let us turn to GDP growth projection for subsequent years beyond CY2024. The GDP growth for CY2025 has been upped by 20 bps while the GDP growth projections for CY2026 has been upped by 10 bps in the March 2024 projections as compared to the December 2023 projections. However, there is no change in the long term sustainable GDP growth has been maintained at the level of 1.80%. The big push to real GDP is expected to come from higher consumer spending and lower inflation reading.
• What about the unemployment projections for the coming years? For CY2024, the unemployment rate is expected at 4.0%; about 10 bps lower than the December 2023 projection of unemployment. This was helped by demand for jobs exceeding supply of jobs in the US market as labour market continued to be tight. However, the long run unemployment is expected to stabilize around the 4.1% levels as per the March update.
• Let us turn to PCE inflation and core PCE inflation projections. For CY2024, the March 2024 updated suggest PCE inflation static at 2.4%; hinting at pressure in the immediate future. However, this has been lowered to 2.2% and 2.0% in calendar years 2025 and 2026 respectively. Interestingly, the core PCE inflation for 2024 has been upped by 20 bps in March 2024 compared to the December 2023 estimates. This could be due to the downstream impact of the Red Sea crisis and also because the supply chain gains may have largely peaked out.
• Now for the big question; what do all these melee of numbers mean for the trajectory of interest rates? If December showed enthusiasm that rate cuts would start soon, it was a return to reality in March. The FOMC projections in March had reduced the rate cut assumption from 4 rate cuts to 3 rate cuts in 2025; which is surprising as it not too clear if the time would be sufficient. There are two things that emerged in May. Firstly, the rate cut enthusiasm of December may have been misplaced. Secondly, the rates are likely to remain higher for longer.

Let us now cut to the present. In the June 12 FOMC meet, the Fed also updated the projections of all these macro variables as of June 2024. Let us see how the June 2024 projections of macro variables compares with the projection of macro variables in March 2024; across all the key macros. For CY2024, there are more data points now.

PRESENT DAY – JUNE 2024 FOMC PROJECTIONS (VERSUS MARCH 2024)

Now we have the latest updates for June 2024 and so we can look at a comparison of the various macro projections like GDP, unemployment, and inflation as updated in June 2024 compared to March 2024. This is part of the routine quarterly updated and the key changes in outlook are visible in the form of the outlook of the Fed on interest rates.

Variable	CY-2024	CY-2025	CY-2026	Longer run
Change in real GDP (Jun-24)	2.10	2.00	2.00	1.80
March-2024 projection	2.10	2.00	2.00	1.80
Unemployment rate (Jun-24)	4.00	4.20	4.10	4.20
March-2024 projection	4.00	4.10	4.00	4.10
PCE inflation (Jun-24)	2.60	2.30	2.00	2.00
March-2024 projection	2.40	2.20	2.00	2.00
Core PCE inflation (Jun-24)	2.80	2.30	2.00
March-2024 projection	2.60	2.20	2.00
Federal funds rate (Jun-24)	5.10	4.10	3.10	2.80
March-2024 projection	4.60	3.60	3.10	2.60

Data Source: US Federal Reserve (CY refers to calendar year)

Here are some of the key takeaways from the FOMC long term projections for the December quarter, pertaining to the likely guidance on macros for next few years.

• Let us start with the GDP growth projected for the coming years. For the current year CY2024, the real GDP is expected to grow by 2.1%. This is at par with the projection in March 2024. Even for future years that is 2025 and 2026; as well as for the long run, there is no change in the real GDP growth estimate. The long run GDP growth is likely to sustain at 1.80%. There are two thing that one can infer. Firstly, the GDP euphoria of Q3-2023 and Q4-2023 has sobered in Q1-2024. This can be attributed to a deliberate compression in GDP due to rate hikes, but that is exactly what the Chef had ordered.
• Let us turn to the unemployment projections for the coming years. For the current year CY2024, the unemployment rate is expected at 4.0%; and there is no change from the March projection. However, the projections for 2025 and 2026 have been raised by 10 bps higher than the March 2024 projection. That is true of the long run unemployment projection also; which is now pegged at 4.2%; a full 70 bps higher than what the Fed defines as full employment. This will reduce the pressure on wages and automatically ensure that the inflation stays in control by putting curbs on consumption spending.
• What about the inflation reading. That is where the Fed expects a good deal of pressure in CY2024 and CY2025, although it is expected to plateau after that. Let us turn to the PCE inflation and the core PCE inflation projections for the coming years. For the current year CY2024, the June 2024 PCE inflation update has been raised by 20 bps from 2.4% to 2.6%. For CY2025, PCE inflation has been upped by 10 bps to 2.3%. That means, even by 2024 end, the Fed only expects the headline inflation to journey towards 2% and not reach 2%. That is likely to happen only in 2026 and beyond. The pressure on inflation is likely to come from the rate cuts that the Fed would effect in 2024 and 2025, plus the combination of the Red Sea crisis and the reduced vibrancy of supply chain gains.
• What does this mean for interest rate trajectory. Now, there are going to be some surprises. For CY2024, the interest rate level has been upped from 4.6% estimated in March 2024 to 5.1% in the June estimates. That means; the best that the markets can expect from the Federal Reserve is one more rate cut in 2024. However, by end of 2024, the rates are pegged at 4.1%, still 20 bps higher than the March 2024 estimates. However, this hints at 4 rate cuts in 2025 by the Fed, which is good news for markets. But the better news is that the by end of 2026, there would be another 4 rate cuts, taking the level of rates to 3.1%.

The moral of the story is that inflation will continue to remain sticky, so the rates are going to be elevated for a longer period.

HOW WILL RBI INTERPRET FOMC JUNE QUARTER PROJECTIONS

There are some positive takeaways from the macro projections in June 2024 as far as the RBI is concerned. Firstly, the average annual GDP growth projections between 2024 and 2026 will stay in the 2% range, which is positive. For the RBI, the concern will be that inflation is likely to stay higher for longer. The RBI has been thinking about pre-emptive rate cuts in India, but it would also want to ensure that it is not totally out of sync with the Fed. From a longer term perspective, the positive takeaway is that rates in the US are likely to come down by 200 bps in the next 2 years. That is less to worry on the global flows front!