September 2024 FOMC Preview

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Summary

Quick takeaways. We dive more into the details below.

What we think will happen:

• Our new baseline is a 50 bps cut with a total of 75 bps of cuts in the SEP for 2024. It’s a close call but we think a 50 bps cut is more likely than a 25 bps cut. While our previous baseline forecast was for a 25 bps cut, there have been several developments this week that point towards a 50 bps cut.
  • The CPI and PPI data point towards a relatively benign core PCE print for August.
  • There is a growing intellectual consensus around a 50 bps cut. Former Fed Vice Chair Donald Kohn favors 50 and former Kansas City Fed President Esther George, known for her hawkishness, said it would be “hard to oppose” it.
  • Several Republican lawmakers have come out in support of cutting at the September meeting, giving the Fed political cover to move before the election. At this point, they risk looking political in the opposite direction by not moving quickly enough.
• We think this will come with a 75 bps of cuts projected in the SEP for 2024. You can think of this as a “hawkish 50 bps.” It is a lot easier to do a hawkish 50 than a dovish 25.

Our view on what should happen:

• We think a 50 bps point cut is the right move. We’ve been calling for it for a while and it’s time for the Fed to catch up after trading timeliness for certainty. Powell’s speech at Jackson Hole was an attempt to keep unemployment expectations anchored; a 50 bps cut next week would demonstrate commitment to that goal. A 25 bps cut sends the message that they’re going to wait to see the labor market start to fall apart before acting.

Scenarios:

While the rest of the Committee doesn’t seem excited about a 50 bps cut, we think Powell can get it over the line. Despite the doves on the Committee not coming out in support of 50, the fact that they haven’t really dismissed the idea indicates that they’ll be on board with 50. The question is whether Powell can get members like Waller to go along with 50. While last week we would not have predicted 50, the recent calls from Republican lawmakers and a benign August inflation nowcast make it more likely that Powell will be able to convince the somewhat more hawkish members of the Committee to start with a 50 bps cut, as long as they don’t signal too many cuts for the rest of the year.

A "hawkish 50" is easier to navigate. They can always add in more cuts later this year if they think it’s warranted, and it would be harder to criticize them for being behind the curve given the initial 50 bps move; they can also delay the cut and still claim consistency with the more cautious pace signaled by only additional cut through the rest of 2025.

On the other hand, a “dovish 25” is at best very awkward. If they put forth 25 bps cuts in September and an additional 75 bps of cuts through the end of the year, it looks like a premature admission that they plan on being behind.

• Our baseline scenario features a 50 bps cut and the median 2024 dot firmly at 75 bps of easing this year. There will be some disagreement on either side; some of the hawks like Logan and Schmid will probably pencil in 50 bps of cuts but still be OK with cutting in September, and some of the doves like Goolsbee may put in 100 bps of cuts.
• Our hawkish scenario indicates a commitment to gradualism expressed by the rest of the Committee. This is the world where Powell fails to forge a consensus on a 50 bps cut.We don’t think it’s likely to see a 25 bps cut in September with more than 75 bps of cuts penciled in for 2024—this would invite too much questioning of why a 50 bps cut is deemed necessary later in the year but not September.
• Dovish scenario: the dovish outcome from this meeting is a 50 bps cut combined with forward guidance of an additional 50 bps of cuts at the November and December meeting, each. This is the world where Powell is firm with the rest of the Committee and convinces a few marginal members—Daly, Williams, and perhaps Musalem (who doesn’t see labor market tightness as a problem anymore) to come along with him.

Between the hawkish and dovish scenario, the hawkish scenario (25 bps cut in September, 75 bps of cuts projected through the rest of the year) is the more likely scenario.

Whether they go for 25 bps or 50 bps, Powell will justify the move as simply recalibrating policy rather than a significant shift towards firefighting mode. They won’t want to confirm suspicions that they are (or were, in July) behind the curve in easing. Expect another statement that they don’t want to see the labor market weaken from here, but also that they’ll use the most recent labor market data to confirm that they’re on the right track.

Latest Fedspeak and Dot Projections

The Developments That Matter:

Between the July and September meeting, the Fed will have seen two months of jobs and nearly two months of inflation data (enough from CPI and PPI to make an accurate prediction of PCE inflation in August). The inflation data for both July came in relatively benign, and the Fed was likely especially encouraged with a substantial fall in supercore inflation. Despite core CPI looking a bit warm in August, there were favorable prints in the financial services, health care, and airfare portions of the PPI, all of which feed directly into core PCE. As of Thursday (after PPI, before IPI), core PCE is on track to print 0.12% month-on-month in August. The good news progress in inflation has been especially pronounced in the key core serves ex-housing portion.

The big turn in Fed policy this meeting is that the Committee now claims to be equally concerned about labor market and inflation risk. The jump in unemployment in July to 4.3% and the triggering of the Sahm rule caught their attention. Although prime-age employment levels are healthy, the momentum of the labor market is clearly slowing even if it is not outright deteriorating. The trend from the past few months of data is clear: hiring has taken a big step backwards, despite low layoffs and job growth has slowed. The soft data from the Beige book suggests that many employers are looking to reduce headcount through attrition. Wage growth may be historically high in terms of nominal growth, but can be justified by the high productivity readings. The job openings number took a big step back in August and by that metric the labor market looks exactly “balanced.”

Meanwhile, the idea of a 50 bps cut has gained traction in recent days. A number of former Fed officials and prominent names in monetary policy have given the nod to a 50 bps cut. Despite Trump opposing the Fed beginning rate cuts before the election, several Republican lawmakers are now on the record as supporting cuts in September. This includes Thom Tillis (R-NC) and John Kennedy (R-LA), the latter of which went so far as to support a 50 bps cut.

Key Fedspeak Since Last Meeting:

• Powell (8/23): "We do not seek or welcome further cooling in labor market conditions."
• Waller (9/6): "I was a big advocate of front-loading rate hikes when inflation accelerated in 2022, and I will be an advocate of front-loading rate cuts if that is appropriate."
• Bostic (9/4): "I am today giving basically equal attention to the maximum employment objective."
• Collins (8/22): Said recent rate decisions were "close calls"
• Goolsbee (9/6): "If you’re going to have a soft landing, you can’t be behind the curve. It’s very clear what’s happening in the economy. Inflation is way down. We’re not overheating. And there are definite warning signs of things over-cooling."
• Williams (9/6): "The labor market is now roughly in balance and therefore unlikely to be a source of inflationary pressures going forward."
• Harker (8/23): "It's somewhere between two and three [cuts]"
• Daly (9/6): "We do have to ensure that we adjust policy as we go so that we don't end up overtightening and weakening the labor market. We're not in that situation and we want to avoid that situation."
• Barkin (8/26/24): On 25 vs. 50 bps: "To me it's about conviction, about how convinced you are... the more convinced you are [of the labor market risk], the [faster you should cut]"
• Musalem (8/15/24): "A tight labor market seems to no longer pose a clear upside risk to inflation."
• Notably absent, Kugler, Cook, Jefferson.

What we’re thinking

The Fed should be cutting by 50 bps at the September meeting. The progress in inflation and the rise in unemployment should have been enough to justify beginning the process of normalization in July, and the subsequent labor market data has affirmed that. The labor market has more than rebalanced, with labor demand underperforming the growth in labor supply and wage growth running low relative to the inflation target and productivity growth.

More generally, we still believe that the path to normalization should feature front-loaded cuts. If the labor market is currently balanced but has been on a slowing trajectory, this speaks to elevated downside risks to the labor market that we do not see as outweigh nebulous upside risks to inflation from “international stability risks.” For months, the Fed has been trading timeliness for certainty; now that they have certainty, it’s time to play catch-up. Finally, uncertainty around the natural interest rate warrants a gradual path of rate cuts—at the end, when we approach neutral, not at the outset.

Instead, the Fed seems to have boxed themselves into a path of gradual rate cuts based not on the data but on institutional inertia and a desire to not spook the markets. This could backfire if it turns out that the Fed has waited too long and has to cut faster later. Instead, the Fed should back up Powell’s commitment to preventing further loosening of the labor market—they can do that by starting with a larger cut.

Here is a quick summary of our recent stances on how the Fed should approach cutting:

• In early July, after the June labor market data, we wrote that the significant progress in inflation and labor market slowing justified a cut at the July meeting.
• In the weeks leading up to the July meeting, Fed officials expressed confidence that the labor market was not faltering due to the fact that layoffs were low. We disagreed, arguing that layoffs were often a lagged indicator and that the Fed should be focused on fire prevention, not firefighting.
• After they declined to cut in July, we argued that a 50 bps cut in September would be warranted if the Fed needed to play catch-up. Soon after, the July labor market data showed an concerning increase of the unemployment rate to 4.3%.
• Chair Powell then spoke at Jackson Hole, cementing a September cut and an explicit goal of not allowing the labor market to soften further. Importantly, he did not endorse a gradual path of rate cuts, a choice we agreed with and thought the rest of the Committee should follow.

Prior to the labor market data for August, we preregistered our thoughts on what should justify a 50 bps cut at the September meeting: an unemployment rate of at least 4.2% and/or a decline in the prime-age employment rate. With the unemployment rate in august coming in at 4.2%, we feel that 50 bps is the right call.

How Has The Data Evolved Since the Last FOMC?