The June Committee forecasts are based on the momentum of Q1 not Q2’s softening. Westpac continues to expect incoming data to justify two cuts in 2024, beginning in September.
The FOMC showed considerable caution regarding both inflation and economic momentum at the June meeting, referencing the strength of Q1 2024 rather than the emerging softening of Q2. March’s median view for 2024 of three cuts has been reduced to one at June. However, four cuts are now seen in 2025 to 4.125%, up from three; while the end-2026 view is unrevised at 3.125%.
Parsing the updated price forecasts, it is apparent that the near-term view for policy is predicated on no further improvement in inflation in 2024 and above-target inflation in 2025. At April, annual headline PCE inflation was 2.7%yr and core PCE inflation 2.8%yr. By December 2024, the FOMC expects those rates to be 2.6%yr and 2.8%yr; and come December 2025, both rates are still seen above target at 2.3%yr.
In the press conference, Chair Powell referenced these forecasts as “conservative” and also recognised that additional outcomes in line with the May CPI report (0.0% headline and 0.2% core readings for the month despite continued strength in the shelter component, 0.4%) would lead to a different, more benign, inflation profile. Asked in the Q&A whether the published forecasts incorporated the latest CPI print, Chair Powell noted that, when significant data is released during the meeting, participants are reminded they have the opportunity to revise their forecasts, but “most people generally don’t”. We believe it is appropriate to take from this information, and the previously telegraphed view that one data print does not make a trend, that the persistence in the inflation forecast at June is a function of 2023 and Q1 2024’s strength rather than the signal of April and May.
Also underpinning their policy view is enduring strength in the labour market; the unemployment rate is expected to peak at 4.2% at end-2025 from 4.0% today after which it edges down to 4.1% at end-2026 – a figure consistent with full employment based on the Committee’s 4.2% ‘longer run’ view. This assessment of the labour market is clearly based on the momentum of nonfarm payrolls, referenced in the press conference opening statement, not the stalling out of household employment survey (a 31k month-average growth pace over the past year compared to nonfarm payrolls 230k) corroborated by the ISM manufacturing and NFIB employment indexes as well as the Beige Book. FOMC members are also clearly not giving any weight to the risk of outright job declines, signalled recently by the ISM services employment index.
Given these views on the labour market, it is unsurprising that the Committee also expect GDP growth to remain above trend over the forecast horizon, at 2.1%yr in 2024 then 2.0%yr in 2025 and 2026. The ‘longer run’ view suggests FOMC members continue to see trend or potential growth at 1.8%. Robust domestic demand in Q1 2024 following a strong 2023 is the basis of this forecast; though, as for the labour market, recent months have pointed to a further slowing in activity growth.
Westpac also expects a robust outlook for the US economy in 2024 and beyond. However, we place greater weight on the emerging downside risks for activity and the labour market. Our baseline GDP forecast is for annual growth to slow to trend by end-2024 and modestly below in 2025, leading to an unemployment rate of 4.5% come mid-2025 – still a very healthy labour market versus history, but one with a degree of slack. We are also mindful that the household savings rate is low versus history and consumers are very cautious on the outlook, particularly for their family finances. As a result, we assess a greater degree of fragility in household demand than was the case in 2023 or 2022 and is evident in the FOMC’s current forecasts.
So, while the Committee now only sees one cut in 2024, we expect the data to justify two, with the first most likely in September. Like the FOMC, we then see four cuts through 2025. While the median expectation for 2024 has come down, it is important to recognise that the majority of the Committee are fairly evenly split on one versus two cuts in 2024, with eight favouring two and seven one – the remaining four are currently for no change. The range of views amongst Committee members for 2025 is broad, further highlighting the data dependent policy approach of the FOMC.
Where we see greater upside risk for inflation and policy is in 2026 and beyond. In 2026, we expect only two further cuts against the FOMC’s unrevised median expectation of four. Consequently, our low point for the fed funds rate for the coming cutting cycle is 3.375% compared to the FOMC’s 3.1%. Beyond the forecast horizon, we also believe inflation uncertainty will likely require the fed funds rate to remain above 3.0% compared to the FOMC’s longer run 2.8% estimate, previously 2.6%.
