Despite hawkish dots, data-driven Fed could still cut in September

As widely anticipated, today’s Federal Market Open Committee (FOMC) rate decision left the target range for the federal funds rate unchanged at 5.25% to 5.50%.

The statement released by the committee showed only one notable change from previous guidance that acknowledged the improvement in recent inflation data. Language that had cited a “lack of further progress” toward the Federal Reserve’s (Fed) 2.00% inflation objective was modified to recognize that “modest further progress” has been made. Aside from inflation, the statement’s assessment of economic activity and the labor market remained upbeat and unchanged from previous meetings.

If there was a surprise in today’s program it came in the Summary of Economic Projections (SEP) where the median FOMC member now calls for just one 25-basis point (bps) rate cut in 2024 when strong market consensus before the meeting had expected two cuts this year. That second cut was ostensibly pushed into 2025, as the median FOMC member now projects four additional 25-bp rate cuts (up from the three in the March SEP). For the second straight meeting, the longer-run dot was moved modestly higher to 2.8%, indicating that some committee members view the neutral level of interest rates as having moved incrementally higher in recent years.

Despite the unemployment rate already sitting at 4.0%, the end of 2024 median projection for the rate was unchanged at 4.0%, setting a relatively low bar for the level of further labor market deterioration that might warrant more substantial policy easing. With regard to the future path of inflation, year-end 2024 and 2025 projections were marked up modestly in response to higher than expected first quarter inflation data, but longer-term projections continue to expect a move back toward the Fed’s 2.00% target by the end of 2026. Projections for real GDP were left unchanged across the board.

In the post-meeting press conference, prepared remarks from Fed Chair Jerome Powell were largely consistent with the prepared remarks from the May FOMC meeting. Powell acknowledged the overall progress made on inflation up to this point, a labor market that’s come into better balance and an economy that continues to expand “at a solid pace.” Balancing out these points of optimism was an admission that inflation still remains too high and that the committee will “need to see more good data” to bolster confidence that inflation is moving durably back toward the 2.00% objective. Powell reiterated that he believes the current stance of policy is restrictive and there remains an expectation that it will continue to exert downward pressure on both economic activity and inflation. Further rate hikes remain an extremely remote possibility absent a meaningful acceleration in the incoming inflation data.

While it can be argued that today’s dot plot delivered a hawkish surprise relative to market expectations, we believe that the big takeaway from today’s meeting is a Fed that continues to operate with a high degree of data dependency—reinforcing that the near-term path of policy rates is dictated primarily by the incoming inflation and labor market data. Given the proximity of the September FOMC meeting to the November elections, we admit that the bar to embarking on a cutting cycle at that meeting is likely higher than it otherwise would be. That said, it remains our expectation that, along with today’s softer than expected May Consumer Price Index (CPI) release, the three additional inflation prints we’ll have in hand prior to the September FOMC meeting will likely meet that threshold. Of course, the state of the labor market at that point in time will also influence the timing and pace of the cutting cycle, but it remains our view that the Fed’s dot plot and the market are currently underpricing the amount of interest rate cuts we’re likely to see in 2024.