The FOMC are sanguine on the growth and inflation outlook, and view the risks as coming into balance.
March’s FOMC meeting communications and forecasts were largely as expected, highlighting policymakers’ confidence in the fight against inflation and achieving a soft landing. The FOMC is on track to begin cutting in June, assuming progress continues to be made with inflation. The bigger risk is the degree of persistence in price pressures into the medium-term, and consequently the end point for this cutting cycle.
The revisions to Committee members’ forecasts were marginal in scale but of significance, signalling greater belief in the durability of activity growth and labour market strength but, at the same time, confidence in returning inflation to target. The Committee now expects growth to remain above potential (1.8%) through the entire forecast period, at 2.1% in 2024 and 2.0% in 2025 and 2026 (previously 1.4%, 1.8% and 1.9%). Little-to-no further deterioration is anticipated for the labour market, with the unemployment rate expected to plateau around 4.0% in 2024-26 from 3.9% currently.
These forecasts recognise the strength of GDP and nonfarm payrolls to end-2023, but give little weight to the downside risks recently evident in the business surveys, measures of labour utilisation (such as hours worked and the number of jobs per worker) and retail sales – spending was marginally lower over January and February combined after a strong 2023. In our view, these risks are nascent but material.
Even with their benign view on activity, the FOMC are confident inflation is on track to swiftly and sustainably return to target. Core PCE is forecast to be higher in 2024 (2.6% versus 2.4% in December) but the projections are unchanged for 2025, 2026 and the longer run – respectively 2.2%, 2.0% and 2.0% (note the longer run figure is for headline). In the press conference, Chair Powell made clear that the upward revision was a response to recent data (a higher starting point) not a change in the perceived current or future composition of inflation pressures. There was also no change regarding the risks to inflation. Housing rent was the only component discussed at length during the press conference. While slow to come through, a material deceleration in shelter is still anticipated over the year ahead. This is critical to the outlook because, in recent months, shelter has made up more than half of total inflation month-on-month.
Where the Committee has grown a little more cautious is with respect to the medium-term risks for inflation. This is evident in the minor revisions to the fed funds rate projection. Three cuts are still anticipated for 2024, but the median number of cuts for 2025 is now only three (previously four). Another three cuts are projected for 2026, as was the case in December, and two more are seen into the long run to 2.6%. While only 10bps above the prior longer run rate estimate of 2.5%, this revision signals some risk of persistent or recurring inflation risks.
While we continue to anticipate an additional cut in both 2024 and 2025 compared to the FOMC’s view (a cumulative 200bps of cuts versus the FOMC’s 150bps), we believe it is more probable that the FOMC will halt the cutting cycle at 3.375% in late-2025, when our forecast horizon currently ends, than continue down to 3.1% in 2026 and 2.6% in the longer run. This is not based on a materially different view of neutral through the cycle, but rather because we anticipate recurring supply-side inflation pressures stemming from tight capacity across housing and infrastructure and due to the US’ decision to reshore production away from Asia, building in a higher cost of production for some goods. We expect US inflation to average closer to 2.5% than 2.0% in 2025, requiring a modestly contractionary stance of policy be maintained to manage both the risks and expectations.
In our view, the implications of such an outturn would be a period of below-trend GDP growth and consequently a degree of persistent slack in the labour market, the unemployment rate holding around 4.5% through at least 2025. These are not terrible outcomes by any means, but do justify a continued downtrend in the US dollar and growing uncertainty over the US fiscal position.
