Fed aims for soft landing with ‘go big or go home’ rate cuts
Outlook: The latest economic data continues to show that the economy is in a gradual decline, with consumers and businesses still spending, but more cautiously. The Fed cut interest rates for the first time since 2020 on the back of a weakening labor market and signs of slowing inflation. Federal Reserve Chairman Jerome Powell emphasized that the policy readjustment is aimed at preventing an undue deterioration in labor market conditions, while insisting on data-driven policy selectivity. .
Looking ahead, the economy is expected to slow into 2025 as restrictive financial policies and rising costs continue to constrain private sector activity, but we believe recession risks remain contained. are. With labor market conditions and income growth slowing further, households will be more cautious in their spending, while still rising financing costs will lead businesses to hire and invest cautiously. Importantly, lower inflation and interest rates, as well as a more balanced labor market environment, should result in slower but more sustainable economic growth in 2025. We expect real GDP growth to average 2.7% in 2024 and slow to 1.8% in 2025.
Worsening labor trends: A combination of a modest 142,000 job gain in August, a recovery in working hours, and a decline in the unemployment rate to 4.2% confirms that the labor market has not fallen off a cliff. However, the large downward revision in pay has pushed the more reliable three-month average pay measure to a new post-pandemic low, indicating a significant softening in employment. We expect business leaders to continue to contain wage growth, hire cautiously, and pursue strategic headcount reductions to contain costs into 2025. We expect the unemployment rate to rise further towards 4.4% by the end of the year and 4.5% in 2025.
Consumer resilience: August retail sales report shows consumers are being more cautious with their spending, but not declining, amid rising prices and interest rates and weaker labor market momentum confirmed. A rebound in consumer spending is not expected given that household budgets remain relatively healthy, but as real disposable income growth slows, household spending is bound to slow from the final quarter of this year into 2025. We forecast consumer spending growth to be below trend in the fourth quarter, average 2.5% in 2024, and slow to 2% in 2025.
Accelerating disinflation: The August Consumer Price Index (CPI) report noted an acceleration in inflation, but sticky shelter factors prevented core CPI inflation from cooling further. Thanks to favorable annual comparisons, headline CPI inflation fell by 0.4 percentage points (ppt) year-on-year to 2.5%, the lowest level since February 2021. Meanwhile, core CPI inflation was unchanged at 3.2%, the slowest pace since April 2021. .
Going forward, the combination of slower spending growth, higher price sensitivity, tighter profit margins, slower wage growth, and lower rent inflation will continue to create a healthy disinflationary impulse. We expect headline CPI inflation to be 2.2% YoY and core CPI inflation to be 2.9% in the fourth quarter of 2024. And the Fed’s preferred inflation measure, the personal consumption expenditures (PCE) deflator, is expected to end the year at around 2.5% year over year, before moving toward the Fed’s 2% target in early 2025. There is.
Easing cycle underway: The Federal Open Market Committee (FOMC) has voted to reduce the federal funds rate by 50 basis points (bps) to 4.75% to 5.00%. Mr. Powell nimbly conducted the press conference, pointing to a policy “recalibration” to neutralize monetary policy rather than a policy response to the recession. This statement has been revised to show the balanced risk of dual obligation, and the dot plot shows a 100bps rate cut this year and next.
Unless the labor market weakens significantly, we believe that policy phasing, featuring one further 25bps rate cut in November and December, will prevail until the end of the year. We expect further easing of 150bps in 2025, bringing the policy rate to 2.9%.
