An interesting disconnect in US rate-cut expectations
Economists and the Fed think similar things on what will happen to the US economy. So why is there a big gap in their expectations for interest rates?
When Jay Powell said in December that the Federal Reserve would lower interest rates by 25 basis points three times in 2024, markets read that as many as six.
Three months later, investors are wholly in sync with the US central bank’s three-cut view. Many economists, however, are not.
A week ahead of the Federal Open Market Committee’s March meeting, FT-Chicago Booth polled a group of 38 academics to ask them what they thought would happen to the US economy this year. They were decidedly more hawkish than either rate-setters or investors, with the bulk expecting two or fewer cuts.
The Financial Times had the scoop and the story, published ahead of the Fed meeting, which is here.
But now that we have the FOMC’s projections, we want to delve into a little more detail on how the poll and the dot-plots stack up.
We want to see what the results might reveal about how the economists and the rate-setters differ in their response to the latest — largely favourable — batch of data on the US economy. And whether or not they have different risk appetites when it comes to deciding it’s time to declare victory on the worst wave of inflation in a generation and finally cut rates from their current 23-year high of 5.25 to 5.5 per cent.
First, here’s what the economists said when asked how many times they thought the Fed would cut this year:
So what explains the disconnect?
It’s certainly not differences in how they view the economy’s prospects. Indeed, comparing the economists’ estimates for growth, inflation and unemployment this year with those of the FOMC would lead one to suspect that the academics would be keener on cuts than the rate-setters.
Those polled are even somewhat gloomier on the jobs market beyond 2024 — when asked what the highest rate of unemployment would be over the next three years, the most common response was between 4.5 and 5 per cent. The FOMC, meanwhile, expects the jobless rate to hit just 4.1 per cent over its 2024-2026 forecast horizon.
The academic economists also view the risk of a recession this year as marginal, and believe that the chances of core personal consumption expenditures, which measure how much consumers are paying for goods and services excluding food and energy products, rising above 3 per cent are relatively small.
This echoes the pronouncements of Fed officials, who believe both that inflation will not substantially bounce back and that the US’s economic strength affords them the patience to act only when they see further signs of price pressures dissipating.
The biggest difference between the two camps, then, is that the Fed is more willing to risk cutting at a time when core inflation is still too high for comfort.
As monetary policy operates with a lag, taking broadly about 18 months for the impact of a change to fully work through the economy, waiting until inflation is bang on 2 per cent isn’t necessarily a good idea.
But what surprises us is that there can be similar takes on the near-term economic outlook yet divergent views on how confident one can be that the FOMC can afford to cut as many as 75 basis points this year. Fed officials, it appears, do have quite a big easing bias — at least when their preferences on rates are set against those of the professors.
By the time we get the next set of poll results and dot plots, we’ll have seen the Consumer Price Index releases up until May, and another three months’ worth of PCE data. That should offer a better idea of whether three cuts — or two or fewer — look about right.