We Expect Faster Pace of Interest-Rate Cuts Than the Fed

Ivanna Hampton: The Federal Reserve is going to wait and see. It held interest rates in place at its September meeting and left the door open for another rate hike this year. Morningstar Research Services’ Senior U.S. Economist Preston Caldwell is here to discuss the Fed’s decision.

Thanks for joining me, Preston.

Preston Caldwell: Thanks, Ivanna.

Hampton: So, what’s the big headline from Fed Chair Jerome Powell’s postmeeting news conference?

Caldwell: Well, as you mentioned, the Fed opted to keep the Fed-funds rate unchanged in its meeting today, and that’s the outcome that had been expected by most market participants in the weeks leading up to today’s meeting. So, in that sense, there wasn’t much news from today’s meeting, but everyone is trying to glean insight on what the Fed will do next. At this stage, the Fed has hiked the Fed-funds rate over 500 basis points from where it was in March 2022. And the question is, What impact will that continue to have on the economy? And most importantly, Will it be enough to quell the high inflation that has racked the economy over the last two to three years?

Hampton: Let’s talk about rate hikes and rate cuts. How does the Fed’s projections line up with Morningstar’s forecast?

Caldwell: We continue to expect a faster pace of Fed-funds rate cuts than the current Fed projects. And that’s because we are expecting a faster rate of inflation reduction. We project the inflation rate, core inflation rate in the fourth quarter of next year to be at 1.9%, just below the Fed’s 2% target, whereas the Fed is expecting it to be at 2.6% at that time. And additionally, we’re projecting the GDP growth rate in the fourth quarter of next year to be at 1%, below the Fed’s 1.5% projection. And so, that weaker growth and inflation coming all the way back to normal, I think will be enough for the Fed to actually cut aggressively in 2024 and 2025, pushing the federal-funds rate down to just over 2% by the end of 2025, which is 175 basis points below what the Fed is expecting.

Hampton: Now, Powell kept saying they need to proceed carefully. What should investors take away from this wait-and-see stance?

Caldwell: He has been quite consistent in that attitude over the last six to nine months, let’s say, since the start of this year. He has adopted the approach that the Fed is going to be data-dependent, while always being a bit ambiguous in terms of what data will lead the Fed to ultimately act in which direction. It’s giving the Fed maximum flexibility, and it’s also recognizing the uncertainty of this situation. Again, as I mentioned, the Fed has hiked by 500 basis points, which is the most since 1980. There is very little concrete, high confidence idea of what that’s going to do in the economy. And we don’t think the effects of those rate hikes are anything fully played out yet. And so, the toll of high interest rates will continue to build up in terms of damage to financial institutions and the rest of the economy and the housing sector, as we’re seeing. And so, the Fed is just going to have to play it minute-by-minute and see what happens in terms of the data.

Hampton: And we’ll all be waiting and seeing what they will do. Thanks, Preston, for your time today.

Caldwell: Thanks, Ivanna.