The scene is set for a September first cut by the FOMC. The underlying inflation trend warrants a series of cuts at a measured pace to a 3.375% terminal by mid-2026.
At the July meeting, the FOMC kept rates steady but stated that the economy is moving closer to the point at which it will be appropriate to lower the policy rate. In the press conference, Chair Powell subsequently asserted that the economy does not need to weaken further to justify an easing cycle. Instead, the catalyst will be confidence in the sustainability of the established downtrend in inflation.
The Committee continue to believe they have time on their side to gauge inflation’s pace and risks. “The unemployment rate has moved up but remains low”, and current momentum is believed to be consistent with a re-balancing of labour demand and supply rather than an outright weakening. Labour market conditions are expected return to a state broadly consistent with that just ahead of the pandemic in 2019, which itself was robust. In the press conference, Chair Powell also highlighted that growth in domestic demand has, to date, remained healthy in 2024.
“Further progress toward the Committee’s 2 percent inflation objective” is therefore desired in Q3 before beginning to ease policy. In thinking about the sustainability of the inflation downtrend and the probability of a September cut, it is noteworthy that annual CPI ex-shelter has, since June 2023, held within a 0.8%-2.3%yr range and averaged less than 2.0%yr. Inflation expectations are now also essentially in line with the decade average on a 1-year and 5-year view (University of Michigan Survey); and, as per the Employment Cost index overnight, wage growth is converging to a pace consistent with maintaining inflation at the 2.0%yr target into the medium-term.
The underlying strength of the economy notwithstanding, “the economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate”. This is a change from the language in the previous statement which highlighted only the risks to inflation. Chair Powell emphasised in the press conference that the FOMC have the capacity to adjust the pace of easing as necessary. Right now, the market is focusing on the downside risks for the labour market – which we have been highlighting throughout 2024 and will get an update on in Friday’s July employment report – and consequently a more rapid and/or deeper cutting cycle than we are forecasting (see below). But, a year ahead, if the underlying strength of the economy holds up, inflation risks will likely assert again – the US’ domestic capacity constraints are real and enduring, and trade policy a meaningful threat.
Westpac’s view of the FOMC outlook seeks to balance these risks. We continue to expect a first cut in September followed by a single cut per quarter from Q4 2024 to Q2 2026 to a 3.375% terminal rate. Against the FOMC’s 2.8% ‘longer run’ estimate (revised up in June from 2.6% at the March meeting) and our own slightly higher view of the likely trend in neutral rates, the end point for the cycle is best considered mildly restrictive. In our view, policy is only likely to return to a neutral or expansionary setting if consumption growth weakens materially below trend: fiscal policy, the green transition and capacity all warrant robust, if not strong, momentum in US investment into the medium term.
 and our own slightly higher view of the likely trend in neutral rates, the end point for the cycle is best considered mildly restrictive. In our view, policy is only likely to return to a neutral or expansionary setting if consumption growth weakens materially below trend: fiscal policy, the green transition and capacity all warrant robust, if not strong, momentum in US investment into the medium term.){kind=link}