“Survive until 2025.”
That’s the slogan Jessica Murphy of Wells Fargo is hearing uttered by investors and some corporate finance types. What they mean, says the bank’s head of commercial rate and FX solutions, is that interest rates in the U.S. will be well on their way back down by then.
But Murphy doesn’t think that’s a foregone conclusion. “And I certainly don’t think it’s a prudent base case,” Murphy told the audience at last week’s New York Cash Exchange conference.
“This idea that rates just have to come back down because they've gone up a lot — that's something I think you want to challenge your thinking on,” she said.
One reason is the rate-hiking cycle that began in March 2022 might not be over.
A recent survey of 40 economists by the Kent A. Clark Center for Global Markets at the University of Chicago and the Financial Times found 48% expect the peak Fed funds rate to be 5.5% to 5.75%. Another 35% chose 5.75% to 6% percentage points. Those ranges are 25 and 50 basis points above the current target range.
In the Summary of Economic Projections (SEP) to be released by the Federal Open Market Committee (FOMC) today, analysts at BofA Securities expect the Fed members’ median policy rate forecast for 2023 to reflect that same 5.5% to 5.75% range.
Jim Griffin, head of cash management at private equity firm KKR, said he’s “in the camp” of the Fed raising one more time this year, possibly in November. “It kind of feels like they want to go one more time just to set it up,” he told an NYCE audience last week, the “it” referring to rate cuts.
“We're going to see some sort of prolonged period at the plateau,” said Anuj Bhatia, a liquidity solutions analyst at Goldman Sachs, at the NYCE conference. However, “we see [the Fed] cutting for the first time in late Q2 or early Q3 [of 2024] … and probably going once per quarter until they get down to a sort of neutral rate,” he said. If a recession were to occur, of course, cuts could come much faster.
“The Fed might not want to cut rates for the sake of cutting rates,” said Bhatia. “I think they're going to need some sort of stimulus.”
Fed Economic Projections
But the U.S. economy has staved off a recession thus far. So why expect a lowering of the Fed funds rate in 2024?
It was the Fed itself that fueled the idea. The FOMC’s SEP, released in June, showed the median projection for the Federal funds rate for year-end 2024 was 4.6%, implying about 100 basis points of rate cuts next year.
The University of Chicago/Financial Times research found that 28% of economists expected the next rate cut to be in the second quarter of 2024 and 23% expected it in the third quarter.
Historically, “typically six to nine months after the last rate hike is when [the Fed] has started thinking they might have a rate cut,” said KKR’s Griffin.
That has proved true twice out of the last three rate reductions after hiking cycles, but deteriorating economic conditions weighed heavily. And in those three instances, benchmark inflation was “contained” or even below 2% when the Fed started easing.
Some may argue that the Fed will ease because policy is in restrictive territory, and a more neutral stance will be called for if inflation continues to drop.
But their outlook may also be tainted by the ultra-low nominal rates from more than a decade of highly accommodative Fed policy.
BofA Securities global research projects the 2024 median policy rate forecast of FOMC members will tick up to 4.875%, reflecting 75 basis points of rate cuts next year, not 100 basis points. They even think core inflation could shift upward in 2024.
“While the Fed will be happy with progress on disinflation, the strength in economic activity leaves the door open for inflation to re-accelerate,” said the BofA research note. “Our base case is that it will not, but we think the Fed would prefer to err on the side of caution.”
In concert with that, the BofA analysts expect FOMC members to increase their fourth-quarter 2023 GDP estimate, slice a little off of the unemployment rate forecast, and lower the fourth-quarter core PCE projection to 3.7%.
For two years from now, 2025, the SEP projection for core PCE inflation was 2.2% at the Fed’s June meeting, near the Fed’s target range. And the midpoint of the Fed policy rate was 3.4%. So the Fed itself was suggesting in June it won’t be close to defeating inflation until 2025. On Wednesday, investors will be watching to see if the FOMC pushes that date out.
Of course, the Fed funds rate may stay elevated for a longer period if:
- tight monetary policy doesn’t plunge the economy into recession;
- the central bank sticks to its 2% inflation target, and inflation stays above it; and
- financial markets avoid any significant hiccups that spread to the real economy.
Not many investors are betting that way, but it’s possible.