We Predict 6 Interest-Rate Cuts in 2024

Ivanna Hampton: The Federal Reserve is keeping the lid on interest rates to close out this year. Meanwhile, the central bank has signaled they could start cutting rates next year. How does this line up with Morningstar’s forecast? Preston Caldwell is here to share his outlook. He is a senior U.S. economist for Morningstar Research Services.

Good to see you, Preston.

Preston Caldwell: Thanks for having me, Ivanna.

Hampton: The Fed held rates steady for a third-straight meeting but is ready to pivot to cuts in 2024. What’s making them feel confident about moving in that direction?

Caldwell: Well, it’s inflation. Inflation has come down quite dramatically. I mean, in the last six months, the PCE core inflation index is now below 3.0%. And on a year-over-year basis, it’s at 3.5%. We expect that to fall further, eventually hitting about 2.4% by March 2024, which is when we expect them to start cutting, actually. Right now, the Fed has not given much indication that they’re going to cut in March, even though that’s what markets believe. We’ve thought that they will start cutting in March for quite some time now, and markets are coming around to our point of view on this. But the Fed itself has been coy somewhat on this matter. But they now are opening the door to at least some rate cuts in 2024 with the latest FOMC projections and [Fed Chair Jerome] Powell also acknowledging that there are downside risks to keeping rates too high for too long, just as there are risks from keeping monetary policy too loose in terms of inflation being too high. But with the inflation target looking under control, it’s now time for the Fed to think about its other mandate of assuring full employment, and that will eventually call for cutting rates.

Hampton: What’s Morningstar’s forecast for interest-rate cuts next year? I mean, how many are you predicting and why?

Caldwell: In addition to the first cut in March 2024, we’re expecting a total of six cuts for the whole year. That will bring the federal-funds rate down from currently at a 5.25% to 5.50% range. It will take that down to a 3.75%-4.00% target range. So, that’s a 150-basis-point reduction from current levels by the end of 2024. And then, we’re expecting further cuts, another 150 basis points of cuts in 2025, taking the federal-funds rate down to 2.25% by the end of that year. And then, even in 2026, we expect it to get down as low as 1.75%. So that’s taking the federal-funds rate really all the way back down to about prepandemic levels. Long-term rates should fall accordingly, and that will help ensure that the economy grows at its full potential, and we don’t see a recession in that we ultimately see the soft landing that is very much possible. Because in contrast to what many people thought a year ago or so, inflation is coming back down to normal without a recession.

Hampton: And the economy has been strong this year. A soft landing looks likely to some market watchers. Fed Chair Jerome Powell says, “It’s too early to declare victory.” Talk about what could tip the economy into a recession.

Caldwell: Right. What we know now is that a soft landing is possible. First, again, we had uncertainty about whether inflation would just be so sticky and entrenched that we would have to have a recession in order to bring inflation down. That’s clearly not the case now, because the supply side of the economy has improved so much in terms of the labor markets and global manufacturing and logistics. Every part of the supply chain has improved. And that’s making it possible to bring down prices, bring down inflation without a downturn in the economy. But that doesn’t mean that it’s assured because in order to avoid a downturn in the economy, we will have to have an appropriately calibrated monetary policy. And by all accounts, right now, the Fed has the federal-funds rate at a restrictive level, that means above its normal expectation that it believes is in the 2% to 3% range. We think it’s about 2%. But, either way, it’s certainly lower than current levels.

So, the question is if the Fed takes too long to bring rates down from these restrictive levels, could that cause a recession? I think ultimately the Fed will be quite expeditious next year in bringing rates down, and it will do so in time to avoid a recession. But if it keeps rates too high for too long, there certainly is that risk because there are parts of the economy that are vulnerable to higher rates. Commercial real estate is one example. I think residential housing also will begin to show strains of these higher mortgage rates. And so that will materialize an economic weakness if the Fed doesn’t change course.

Hampton: Well, Preston, thank you for your outlook today.

Caldwell: Thanks, Ivanna.