Fed June statement reduces rate cut guidance to just one in 2024

14 Jun 2024 , 11:28 AM

FED HOLDS STATUS QUO ON RATES

When the Fed presented the policy statement for June 2024, there were never any expectations of a rate cut. The Fed has held the benchmark rates in the range of 5.25% to 5.50% since the middle of last year. However, the big challenge has been inflation. For instance, the US CPI inflation, which was announced on the same day as the policy statement, came in 10 bps lower at 3.3%. The challenge for the Fed is that the inflation is still a good 130 bps away from the target of 2.0% and that is not great news. In the last 2 months, the CPI inflation in the US has just tapered by 10 bps each month from 3.5% to 3.3%. This has been facilitated by flat food inflation and lower core inflation, while the energy inflation has trended higher. With the outlook for oil still unclear, the Fed would surely want to take it easy when it comes to rate cuts. That was the theme this time!

FED CUTS RATE GUIDANCE TO JUST ONE CUT IN 2024

In the previous policy presented by the Fed on May 01, 2024, the markets was actually surprised that the Fed did not hint at any change in its “minimum 3 rate cuts” stance expressed in the March 2024 policy statement. Most analysts and economists were wondering how 3 rate cuts would be possible in 2024, when the Fed was yet to give guidance on the first rate cut, and any action before September looked unlikely. Now there is some rationality in the Fed statement as it has explicitly reduced the probability of rate cut to just one rate cut of 25 bps in 2024. However, the Fed has also hinted that if inflation supported, then rate cuts would be expedited in 2025. That looks logical since with the first rate cut likely only in September, 3 rate cuts would have been too much to expect. However, the CME Fedwatch is still assigning a probability of 2 possible rate cuts in 2024, although the second rate cut has been assigned a probability of just about 50%.

KEY SIGNALS FROM THE JUNE 2024 FED STATEMENT

The tone of the Fed statement in June continued to be very cautious, with the hawks clearly having an upper hand. Fed was unwilling to commit to any time table on rate cuts but it looks like July is ruled out and the first possible rate cut may only happen in September. Here are some of the signals we gathered from the Fed Statement for June 2024.

• The Federal Reserve on Wednesday kept its key interest rate unchanged and signalled that just one cut is expected before the end of the year. That sounds more like a logical move considering that 3 rate cuts would not logically fit in if the first rate was taken up in September. However, even this is predicated on inflation falling decisively from here.
• The Fed did offer an optimistic note in that the inflation had eased in last one year, albeit remaining elevated in absolute terms. The tone was similar to the previous statement; cautiously optimistic. The Fed statement used the words “modest further progress” towards the target of 2% inflation on a sustainable basis. This is a clear shift from the May 2024 language, which said, “lack of further progress on inflation.”
• If you look at the dot plot given out by the various members, the expect the single rate cut in 2024 to be compensated by aggressive rate cuts in 2025. The CME Fedwatch itself is pencilling around 3 to 4 rate cuts in the first half of 2025 i.e., by the July 2025 Fed meeting. The Fed is now pegging 100 bps rate cuts in 2025 or even higher, if supported by sustained lower levels in inflation in the coming year.
• One interesting takeaway from the dot plot chart is that higher long term equilibrium rates may be the name of the game. For instance, the members of the Fed now peg the long run rate of interest 20 bps higher at 2.8%, against 2.6% in the previous estimate. At the same time, the number of rate cuts in 2025 have been reduced from 6 cuts to 5 cuts.
• Compared to March, the headline inflation and the core inflation for the current year and the next year have been upped by 20 bps. This is largely on the back of the pressures coming from the West Asia and Red Sea crisis, which his likely to see oil on the boil for some more time. Also, the Fed is likely to shift its focus on core PCE inflation.
• In his statement, Powell said that while the data was encouraging, it was not robust enough to warrant rate cuts at this juncture. What suits the Fed is that the economic data softened in Q1, as depicted by the 1.3% GDP growth estimate. While that is safe from the recession worries, it will help to tame consumption and wages in the US.

To sum it up, the markets had 3 reasons to cheer. Firstly, the Fed has reduced the rate guidance to 1 cut in 2024, but promised to compensate with more aggressive rate cuts in 2025. Secondly, the Fed has also underlined that rate hikes were off the agenda, except in very extreme of black swan kind of situations. Lastly, the Fed has promised that the action on rates would be immediate, the moment the central bank was convinced that the inflation was decisively moving towards the 2% target. There would no time lag then.

CME FEDWATCH STILL ALIGNED TO 2 RATE CUTS IN 2024

One way to look at the Fed outlook from a market perspective is to evaluate the CME Fedwatch. This captures the probabilities of rate moves in various upcoming Fed meetings, based on the implied probabilities of Fed Futures trading. We have considered data up to July 2025 Fed meeting. One big question after the Fed Statement is; whether the CME Fedwatch is still reflective of the real story?

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	10.3%	89.7%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	6.6%	61.1%	32.3%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	2.6%	27.9%	49.8%	19.7%
Dec-24	Nil	Nil	Nil	Nil	Nil	2.2%	22.2%	44.9%	26.5%	4.5%
Jan-25	Nil	Nil	Nil	Nil	1.3%	15.4%	36.6%	32.9%	12.1%	1.5%
Mar-25	Nil	Nil	Nil	0.9%	10.9%	30.0%	34.1%	18.7%	4.9%	0.5%
Apr-25	Nil	Nil	0.4%	5.7%	20.0%	32.0%	26.8%	12.1%	2.8%	0.3%
Jun-25	Nil	0.3%	3.8%	14.8%	27.6%	28.7%	17.5%	3.2%	1.2%	0.1%
Jul-25	0.1%	1.7%	8.2%	20.0%	28.0%	24.1%	12.9%	4.2%	0.7%	0.1%

Data source: CME Fedwatch

The CME Fedwatch has been broken up into two milestones; December 2024 and July 2025. These are market driven implied probabilities based on Fed futures trading. These probabilities in the CME Fedwatch undergo a shift based on how the market looks at the likelihood of rate cuts / rate hikes in the coming 12 months; based on any big event. This time, it is in the aftermath of the US consumer inflation, Fed policy statement and the Fed long term projections of key macros. There is a clear shift in probabilities towards the right side of the distribution; but while the CME Fedwatch has turned hawkish for 2024, it has turned relatively more dovish for 2025.

The CME Fedwatch remains a strong market driven indicator of rate cut expectations; although it may not always be accurate as it only signals expectations. Let us look at the first milestone of December 2024. The CME Fedwatch has assigned a probability of 95% to at least one rate cut in 2024. In addition, the CME Fedwatch is assigning a good 69% probability to at least two rate cuts till the end of 2024. Will the situation change in 2025? That is still a long time away and a lot of data points will flow in the intervening period. However, by July 2025, the CME Fedwatch is expecting 3-4 rate cuts with a much higher probability and also with greater speed in 2025.

FED THEME – RATE CUTS WILL BE GRADUAL, BUT WILL CERTAINLY HAPPEN

The one thing that comes out explicitly from the Fed statement is that the Fed continues to remain ambivalent on rate cut and is likely to remain ambivalent in the near future on the rate cuts front. However, three rate cuts are off the table in 2024 and the Fed itself has admitted that not more than 1 rate cut is likely in 2024. However, the Fed has also guided for more aggressive rate cuts in the year 2025. It will still depend on inflation trajectory.

• There were interesting insights in the Fed policy statement. The restrictive stance on monetary policy is having the desired effect on inflation, as per Powell. However, central bankers were still waiting to see sufficient progress. While it does not mean inflation touching 2%, the Fed wants to see decisive progress towards 2% inflation.
• There was some clarity on likely rate hikes. According to Powell, no Fed member had rate hikes in their base case. Apparently, interest rates were not even on the agenda at this juncture. According to Powell, the consensus is that, the policy is restrictive enough to taper inflation lower, even if it means some impact on the US economic growth.
• Jerome Powell underlined that the central bank still did not have the confidence to start lowering interest rates. This is despite CPI inflation for May coming in 10 bps lower at 3.3%. According to Powell, the concerns are that the energy inflation is too elevated at this point and reduction in food and core inflation may have already seen their best days. However, there was confidence that rate cuts can commence soon.
• Powell underlined that finally the GDP data and the labour data was coming in sync with their 2% inflation goal. For instance, the labour market had come into better balance while the GDP growth in the first quarter of 2024 had cooled to 1.3% based on the second estimate of Q1 GDP. However, a few swallows do not make a summer, and hence the Fed would wait for more ratification to ensure that inflation
• Considering the soft inflation in May 2024 at 3.3% and hopes that PCE inflation may also taper lower, the soft inflation surely eases fears that labour market strength could drive renewed inflation strength. It also underlines and corroborates the view given by Powell that the hot inflation data of Q1 was just a bump in the road, and not a sign of things to come. It was more like the exception that only served to underline the rule.
• What does the Fed statement mean for rates and the trajectory of rates over the next year and half? The inflation print and the cautious Fed statement have kept September Fed cut firmly in the picture; however, pre-emptive cuts in July are now ruled out. Fed will wait for more evidence on tapering prices before taking a call on rates. However, even the Fed has admitted that there could be more back-ending of rate cuts in 2025.

Interestingly, the banks in the US are paying higher rates to attract deposits and that means rate cuts would, anyways, take longer to reflect on consumer rates. It looks like Catch-22.

HOW WILL RBI INTERPRET JUNE 2024 FED STATEMENT

RBI implemented its last rate hike in February 2023 and kept status quo in the next 8 meetings, including the latest policy statement in June 2024. For the RBI, the real problem is food inflation which is still elevated, especially due to vegetables and pulses. These two items have been in high double digits for more than a year now. The heat wave conditions will not permit food inflation to come down rapidly; despite the IMD projecting normal rainfall in this year. For now, RBI will prefer to wait and watch till the full budget is presented in mid-July as is expected. However, with the data at its disposal, one need not be surprised if the RBI goes for pre-emptive rate cuts in August. But, that is still a long way away.