Fed Rate Cuts Will Likely Be Slow—but Not Necessarily Steady

There’s a saying about how the Federal Reserve manages interest rates: ‘They go up the escalator and down the elevator.’ This time, it will likely be the reverse—frustrating investors betting on a quick decline.

Rates shot up in 2022 and 2023 at the fastest pace in four decades as the central bank sought to contain surging inflation. Now, with price pressures easing and the economy still strong, Fed officials are prepared to bring rates down at a slower and potentially less regular pace.

Several Fed officials have offered hints in recent days about what that might look like in practice, with most uniting around a cautious and slow approach. Vice Chair Philip Jefferson cited the mid-1990s, when the Fed achieved a soft landing for the economy by cutting rates, pausing for three meetings, and then lowering rates further.

“The Fed can be patient in every aspect this time around,” said Lindsey Piegza, chief economist for Stifel Financial Corp. “The pathway forward, once the unwinding of policy firming has begun, is likely to be less uniform and predictable than the market is anticipating. The Fed has no incentive to rush to provide accommodation.”

The pace has important implications for consumers and businesses—the Fed’s benchmark rate influences lending costs for mortgages, cars, and credit cards—as well as for the presidential election. Falling rates might be seen as providing a boost to President Joe Biden.

But the fundamentals of this cutting cycle also look a lot different than most. While the Fed typically lowers interest rates in response to recessions, the U.S. economy has remained surprisingly resilient. At 3.7 percent, the unemployment rate is virtually the same as when the central bank began ratcheting up rates in March 2022.

That strength, paired with higher-than-forecast inflation in January, reinforces the cautious approach pitched by policymakers, not just for the first cut but also for future cuts. Officials have also repeatedly stressed the need to base their decisions on incoming economic data. Governor Christopher Waller said last week the central bank should be “patient, careful, methodical.”

What Bloomberg Economists Say…

“We don’t think rate cuts necessarily need to be in SEP meetings, or every other month. It really depends on the data flows. But we expect 125 bps in 2024, starting in May.”

—Anna Wong, chief U.S. economist

“Given low unemployment and an economy that appears to be rolling along at a healthy growth rate—it looks like the philosophy is: ‘First, do no harm,’” said Kathy Jones, Charles Schwab’s chief fixed-income strategist. “There is plenty of room to cut if the economy weakens, but a rebound in inflation would be more difficult.”

Fed officials welcomed the surprising pullback in price pressures late last year, but some have cautioned that improvement has largely centered on energy and goods while services costs remain stubbornly elevated. Hotter-than-expected employment and inflation figures have also shifted market expectations, with investors now betting the first rate reduction will be in June or July.

Data due out Thursday is expected to show inflation, as measured by the Fed’s preferred gauge, accelerated on a monthly basis in January, according to economists’ forecasts.

The Federal Open Market Committee (FOMC) projected three rate cuts for this year, according to officials’ December median forecast. Policymakers will update their outlook at the March 19 and 20 meeting, but the timing of cuts may be hard to predict.

Philadelphia Fed President Patrick Harker advocated last week for a “steady, slow reduction” in rates to minimize risk and general uncertainty. Cleveland Fed President Loretta Mester, meanwhile, has said it’s not necessary to make rate moves only at meetings when officials submit updated quarterly economic forecasts, “as long as we are communicating well.”

In 2004 to 2006, Alan Greenspan had a policy of “measured” hikes of a quarter-point per meeting, which some Fed officials believe led financial markets to become too complacent, a predictability Fed officials might not emulate this time.

One option is to take cuts in two stages, starting with a few quarter-point cuts followed by a potentially lengthy pause, Deutsche Bank economists led by Matthew Luzzetti said in a note Monday.

“It’s difficult for them to say they’re putting rates on a glide path to what they think the neutral level is, if they don’t know what that neutral level is, and especially if it could be materially higher than what they previously thought,” Luzzetti said in an interview.

Any surprises might open the Fed up to political criticism. Former President Donald Trump has said he wouldn’t reappoint Chair Jerome Powell if he wins a second term in November.

“If the moves look random, then it potentially creates a problematic appearance,” said Stephen Stanley, chief U.S. economist at Santander U.S. Capital Markets LLC. “Presumably they are responding to the data. As long as they can make a credible case that they are data-dependent, I think they are OK.”

Copyright 2024 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.