The Federal Reserve began the process of normalizing interest rates at the September 18th, 2024 FOMC meeting. While the timing of the first rate cut was telegraphed well in advance, the magnitude—25 or 50 basis points—was not. A week prior to the meeting, market pricing, as well as surveys of major Wall Street financial institutions, leaned heavily towards a 25bp cut, but we decided to change our prediction of the Fed’s September move to a 50bp call. We had prescriptively advocated for 50bps as early as the July jobs report, not just because the data itself looked concerning but because it fit what we had laid out in December 2023: the case for frontloading interest rate normalization cuts if confronted with downside risk. In the end, not only did the Fed cut by 50bps; the stated motivations behind their move echoed core theoretical justifications that we were among the first to lay out.
Our Prediction Of A 50 Basis Point Cut In September
As a matter of principle, we are always explicit about what we think the Fed will do versus what we think it should do. Many strategists and forecasters tactically stake out lower probability stances for the sake of being provocatively unique, or else herd with the crowd purely due to reputational incentives. We strive to avoid that, and simply give you the best evidence-based view available. We’re not afraid of indicating a change in our stance if the evidence cuts against our established view, or even a complete 360 round-trip, as occurred with our Fed call in September.
As we entered the blackout period to the FOMC meeting, speeches from Governor Waller and NY Fed President Williams caused us to shift our descriptive prediction to 25bps. On most occasions, officials of that stature are worth following, even though the signal was at odds with Chair Powell’s decisively dovish Jackson Hole speech that intentionally left the door open to 50bps. However, multiple developments during the blackout period led us to change our call to a 50bp cut by September 12th.
The first key development was the inflation data received during the blackout period prior to the meeting. August Core CPI and aggregate PPI both came in warmer than anticipated, leading most observers to consolidate their view toward a 25bp cut. However, our PCE Nowcast (“Core-Cast”) operates on a deeper understanding of the precise construction of the PCE Price Indices and indicated a much softer month-over-month core PCE inflation print, just 12bps at the time. As the titles alone foretold (Post-CPI: Despite Surprising Housing Lags, PCE Implications Are More Benign & Encouraging; Core-Cast Post-PPI: If Core CPI Was Supposed To Kill A 50bp Cut, PPI Details Suggest It's Not Dead Yet), the Core PCE tracking was potentially Fed-relevant.
This turned out to be crucial to understanding the Fed’s move to a 50bp cut. After the meeting, Chris Waller—a pivotal member of the Committee for this move—explicitly cited the CPI and PPI data’s implications for core PCE inflation as the data point that ultimately pushed him towards a 50bp cut.
Second, a group of Republican lawmakers came out in support of a September interest rate cut the Wednesday before the meeting. This included two Republican Senators on the Banking Committee, Thom Tillis (R-NC) and John Kennedy (R-LA), with the latter even calling for a 50bp cut. This provided the Fed with curiously timely political cover in an election year, especially as former President Trump warned the Fed not to cut before the election.
Finally, and most decisively for our call, several prominent voices in monetary policy voiced their support for a 50bp cut. Nick Timiraos of the Wall Street Journal wrote a piece in which several prominent names in monetary policy - including Jon Faust (Chair Powell’s former special advisor), Don Kohn (former Fed Vice Chair), Bill Dudley (former NY Fed President), and Esther George (former KC Fed President and known inflation hawk) - laid the case for a 50bp cut. Colby Smith of the Financial Times also wrote a piece, again, featuring Don Kohn in addition to Loretta Mester (former Cleveland Fed President) and Krishna Guha (former EVP at the NY Fed), suggesting that 50bps was firmly on the table for September. Many of these voices are both credible and do not routinely offer their views and intellectual justifications for Fed policy moves.
When we changed our prediction to a 50bp cut on the Thursday afternoon before the meeting, market-implied odds for a 50bp cut were around 20-30%. Very few banks and economists thought a 50bp cut was the most probable outcome. While it was understandable to first lean on Williams and Waller’s speeches, our more careful combing of both the inflation data and the voices of key Fed alumni gave us the confidence to land on a 50bp call.
Our Advocacy For A 50 Basis Point Cut In September
Long before we predicted that the Fed would begin with a 50bp cut, we were actively advocating for it. As early as December 2023, EA Executive Director Skanda Amarnath and EA Senior Economist Preston Mui laid out the case for kicking off the interest rate normalization cycle with a 50bp cut in “Three Motivations for Interest Rate Normalization: a Playbook for Fed Policy in 2024.” They argued that when the process of rate normalization began, the path of rate cuts should be faster up front to preempt downside labor market risk if at all visible.
The process of rate normalization ended up starting later than many anticipated, due to a bumpy first quarter of inflation readings. As we noted in real-time, this was not due to any genuine reacceleration in inflation. The elevated Q1 inflation readings were due to residual seasonality and other idiosyncratic factors. Given the slowdown in the labor market and inflation data in the subsequent few months, we thought there was ample evidence for the Fed to begin interest rate normalization at the July FOMC. Unfortunately, poor communications heading into the meeting likely boxed the Fed into making the mistake of holding rates steady.
We soon argued that a 50bp cut should be under strong consideration at the September meeting, a view we soon fully endorsed when the July labor market data showed a concerning rise in the unemployment rate. Many Fed officials were still being too nonchalant about the need for preemptive action, and talking up lagging indicators, including layoff rates, instead of the more forward-looking risk management posture we have been calling for.
Powell's Jackson Hole speech earned our praise for decisively declaring (1) that the balance of risks had shifted toward the labor market, (2) that he did not seek any further cooling in the labor market, and (3) that the Fed need not prematurely commit to an incremental path of rate cuts. This stood in stark contrast to other members who were still prescribing cutting in 25bp increments and using the phrases “gradual” and “methodical” to describe the path down. Finally, we argued that a 50bp cut would be a way for the Fed to effectively anchor "unemployment expectations" by showing they are serious about getting ahead of the curve and preventing the labor market from deteriorating.
The Fed Has Adopted Many Of Our Arguments
In the end, the Fed did more than cut rates by 50bps in September—they also adopted some of the arguments we made for front-loading cuts.
At the press conference, Chair Powell made very clear that the motivation for cutting 50bps was to preempt the labor market from further softening. He noted that if you wait until you see layoffs rising, it’s too late to act—exactly what we’ve been arguing.
“We're not waiting for [layoffs], because there is—there is thinking that the time to support the labor market is when it's strong, and not when we begin to see the layoffs. There's some lore on that.”
Jay Powell, Sept. 18th FOMC Press Conference
Chair Powell also seemed committed to anchoring unemployment expectations in his public messaging, highlighting that “you can take this [50bp cut] as a sign of our commitment not to get behind” the curve on labor market downside risk.
After the meeting, other FOMC members echoed similar remarks. Chicago Fed President Goolsbee warned about the nonlinear labor market risks and that several cuts would be needed to secure the soft landing. Atlanta Fed President Raphael Bostic, who tilts hawkish, followed up with remarks declaring that monetary policy normalization would come sooner than he anticipated. Even Minneapolis Fed President Neel Kashkari—who would have been considered hawkish during recent years—voted for a 50bp cut and even used the same reasoning that we used to argue that frontloading cuts and going more slowly later would be an appropriate way to address neutral rate uncertainty:
"At some point, we're going to be coming into the question of are we at around neutral... I think after 50bps we're still at a net tight position, so I was comfortable taking a larger first step, and then as we go forward I expect on balance we will probably take smaller steps."Neel Kashkari, CNBC 9/23/24
There are still many uncertainties surrounding the labor market, but the decision to cut by 50bps was the right decision, and the shift in Fedspeak from most of the committee to support the labor market puts us on the right track to a soft landing.
