Fed Sep-24 projections bets on front-loading rate cuts to save jobs

19 Sep 2024 , 03:52 PM

FED PROJECTIONS UPS JOBS SCARE, FRONT LOADS RATE CUTS In a sense, the September 2024 policy statement of the US Federal Reserve marked a watershed in the way the Fed has managed the recent interest rate cycle post the pandemic. The rate hike cycle which started in March 2022, resulted in a total of 11 rate cuts of 525 basis points till July 2023. The mandate all through was clear. Inflation had to be brought down at all costs. After all, inflation not only hits the most vulnerable segments of the economy, but also constrains real GDP growth. Even though the Fed had stopped rate hikes in July 2023, it did not cut rates as it was wary of triggering inflation. September 2024 policy was the watershed as it marked the shift in Fed policy intent from inflation focus to jobs focus. Clearly, it was not worth trading more jobs for lower inflation further. Along with the Fed policy statement on September 18, 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. These macros are the building blocks and they eventually go into the Fed trajectory for interest rates. These projections are updated each quarter for the next 3 years and also for the long run. The big change in September 2024 update was that the Fed is pencilling in higher than expected unemployment and lower than expected inflation. The result is a rapid and aggressive front-ending of rate cuts by the Fed. Each quarter, the update by the Fed incorporates the major changes in the quarter. In March, the Fed had upped its GDP estimates, but that was kept static in June. That was not surprising since the US Q1 GDP had come in at 1.4%. In June, the Fed had also upped the core PCE inflation projections as well as the headline PCE inflation projections by 20 bps for calendar 2024. It was to reflect the trade disruptions caused by the Red Sea crisis and the impact on global commodity prices. In September 2024, the Red Sea crisis has almost become a footnote. However, the US unemployment rate has spiked to 4.2% and that is forcing the Fed to act. After all, the Fed has spent the last 4 years trying to avoid a hard landing and has successfully managed to contain inflation without triggering a growth scare. That comfort level has just changed in the September quarter; which explains why the Fed has taken up a philosophical shift from inflation control to jobs expansion. 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) What exactly did we read from the macros of the last 5 calendar year up to the end of 2023. Let us start with the real GDP. It had been consistently above 3% till 2019. We will have to ignore the period between 2020 and 2021 as it was a sharp fall followed by a recovery. CY2022 offered a clearer trend with GDP growth at 0.7%; largely on account of high inflation triggered by the Russian war situation in Ukraine. This changed in the year 2023, with the boost to US GDP coming from a sharp fall in PCE inflation. Incidentally, the nominal GDP was at the same level in 2022 and 2023, with inflation making all the difference. Let us focus on two other aspects; inflation and unemployment. On the inflation front, a clear moderation is evident post 2022as the rate hike impact started to set in. After averaging 5.9% in 2021 and 2022, the headline PCE inflation has more than halved to 2.8% in 2023 and is likely to trend to around 2.3% in 2024. The core PCE inflation has also fallen in tandem with the headline PCE inflation in 2023, although with the supply chain constraints resolved, further downsides could be restricted. In short, the hawkish policy of the Fed has managed to contain inflation appreciably; but without impacting the nominal GDP growth or worsening the jobs situation. That situation has shown signs of changing since July, which explains the shift in the Fed strategy from September 2024 onwards. More on that later! RECAP – JUNE 2024 FOMC PROJECTIONS (VERSUS MARCH 2024) We now have the latest updates for September 2024 and so we can look at a comparison of the various macro projections like GDP, unemployment, and inflation. However, to get a sense of context, it would be worthwhile to quickly loo at the Fed projections in June compared to its projections in March 2024. The table recaps how the June projections compared with the projections in March 2024.

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 year 2024, the real GDP is expected to grow at 2.1%. This is at par with the projection in March 2024; so not much change on that front. 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%; although by current estimates it could be higher. There are two takeaways. Firstly, the GDP euphoria of Q3-2023 and Q4-2023 has sobered in Q1-2024. That means, holding rates at elevated levels for a long period is starting to have its impact in terms of flattening the GDP growth traction.
• 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. The long run unemployment projection is pegged at 4.2%; a full 70 bps higher than what the Fed defines as full employment (3.5%). This will curb consumption spending; although it is also likely that it could have repercussion in terms of consumption driven growth in the US economy.
• What about the inflation reading. That is where the June projections had pencilled in good deal of pressure in CY2024 and CY2025. Let us turn to the PCE inflation and the core PCE inflation projections for the coming years. For CY2024, the June 2024 PCE inflation update has been raised by 20 bps from 2.4% to 2.6%; largely as an outcome of the pressures exerted by the Red Sea crisis. That has not only raised freight costs, but also raised the insurance charges. For CY2025, PCE inflation has been upped to 2.3%. The headline inflation was to see 2% only in the year 2026. The pressure on inflation is expected to come from the crisis in West Asia and the Middle East; as well as the rate cuts that the Fed would effect in 2024 and 2025. It would be a mix of demand pull and supply push factors.
• Now for the holy grail; what does this mean for interest rate trajectory. June had some real unfriendly 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 hinted at just one rate cut in 2024. Back in June, there were 4 rate cut estimates for 2025, 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%. However, we will see how that has changed drastically based on the September 2024 update given by the Fed.

The narrative in June 2024 was that inflation will continue to remain sticky, so the rates are going to be elevated for a longer period. Let us now cut to the present situation. PRESENT DAY – SEPTEMBER 2024 FOMC PROJECTIONS (VERSUS JUNE 2024) Now we have the latest updates for September 2024 and so we can look at a comparison of the various macro projections like GDP, unemployment, and inflation as updated in September 2024 over June 2024. Let us see how the outlook for various macros has changed between June and September.

Variable	CY-2024	CY-2025	CY-2026	Longer run
Change in real GDP (Sep-24)	2.00	2.00	2.00	1.80
June-2024 projection	2.10	2.00	2.00	1.80
Unemployment rate (Sep-24)	4.40	4.40	4.30	4.20
June-2024 projection	4.00	4.20	4.10	4.20
PCE inflation (Sep-24)	2.30	2.10	2.00	2.00
June-2024 projection	2.60	2.30	2.00	2.00
Core PCE inflation (Sep-24)	2.60	2.20	2.00
June-2024 projection	2.80	2.30	2.00
Federal funds rate (Sep-24)	4.40	3.40	2.90	2.90
June-2024 projection	5.10	4.10	3.10	2.80

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 September 2024 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 2.0%. This is lower than the projection in June 2024 at 2.1%; by a total of 10 bps. However, for the future years of 2025 and 2026; as well as for the long run, there is no change in the real GDP growth estimate, which remains pegged at the real rate of 2.0%. The long run GDP growth is likely to sustain at 1.80%. There are two key takeaways here. Firstly, the GDP shocker of just 1.4% growth in Q1-2024 has seen some improvement, trending closer to 3.0% in Q2-2024. That means; full year GDP growth of 2.0% plus is still feasible. GDP story is not being impacted, leaving the Fed to tackle the worsening of the jobs data alone.
• Let us turn to the September 2024 unemployment projections for the coming years; and how it compares with the previous projection in June 2024. For the current year 2024, the unemployment rate expectation has spiked to 4.4%; up from 4.0% in the June projection. Clearly, the recent worsening of the jobs data has triggered this shift. However, the projections for 2025 and 2026 have also been raised by 20 bps over the June projections, hinting that the jobs situation may take longer to rectify. However, the long run unemployment rate has been held at 4.2% in September 2024; same as in June 2024. This will reduce the pressure on wages and keep inflation in check, but it diverges from the Fed stated objective of ensuring near full employment.
• What about the inflation reading. That is where the Fed has sharply lowered the inflation projection for CY2024 and CY2025. That also justifies the shift that the Fed has undertaken in the September 2024 policy to move its focus from inflation control to creation of jobs and reduce the level of unemployment in the US economy. For the current year CY2024, the September 2024 PCE inflation update has been cut by 30 bps from 2.6% to 2.3%. For CY2025, PCE inflation has been cut by 20 bps from 2.3% to 2.1%. That also means that 2% inflation will remain elusive in 2025 also and will only be achieved by 2026. However, the Fed is also pencilling rate cuts of up to 250 bps by middle of 2026. It remains to be seen if such low inflation can really co-exist in the midst of such aggressive interest rate cuts by the Fed.
• What does this mean for interest rate trajectory. Now, there are going to be some positive surprises for the doves. For CY2024, the interest rate level has been cut sharply by 70 bps from 5.1% in June 2024 to 4.4% in September 2024. That hints at another 50 bps cut by the Fed by end of 2024. However, by end of 2025, the rates are pegged at 3.4%, again 70 bps lower than the June 2024 estimates. That would imply another 4 rate cuts of 25 bps each in the year 2025. Rates are likely to stabilize at 2.9% for long term.

The moral of the story is that the Fed is shifting its focus from inflation control to ensuring full employment. HOW WILL RBI INTERPRET FOMC SEPTEMBER QUARTER PROJECTIONS There are some interesting takeaways from the macro projections in September 2024 as far as RBI is concerned. Firstly, the average annual GDP growth projections between 2024 and 2026 will stay in the 2% range, which is positive. However, the Fed has expressed satisfaction at the inflation progress and it is shifting gears from inflation control to expanding jobs. Whether it will be inflationary or not is debatable. For now, the global thinking is likely to turn dovish and the RBI cannot afford monetary divergence for too long. The Fed September projections shows the silent shift in the Fed thinking and that is likely to influence global monetary policy. RBI will surely take cognisance of that!